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Disbursement System

Disbursement System include the banks and


the delivery mechanism and procedures firms
use to transfer of cash from the firms
centralized cash pool to disbursement banks
and then on to supplier and other payees.
Disbursement system are simpler because
headquarters control it more directly.

Objective

By slowing down cash disbursement as much


as possible and accelerating cash collection,
the desired objective of cash disbursement is
to increase the availability of cash or retain
the cash as long as possible.

Disbursement Policy: 4
Principles

Maximize value through payment timing


Optimize the accuracy and timeliness of
information
Minimize balances in disbursement accounts
Prevent fraud

Maximize value through


payment timing

Payment should be timed to add the


maximum value to the company
First for a cash poor company, it should pay
on terms but not before
A company should take cash discount when it
is available
Within ethical, legal, and practical constraints
a company should take advantage of float
offered by strategic location of disbursement
bank.

Optimize the accuracy and


timeliness of information

Accuracy and timeliness of information are


key attributes of disbursement system.
Providing accurate information in a timely
manner without incurring excessive cost
Accurate fund balance information received
early in the days add value through access to
investment with higher interest

Types of Disbursement
Decisions

Strategic Decisions Decisions that have


long term effect and cannot be changed
immediately.
Tactical Decisions- Day to day operating
decisions.

Disbursement Decisions

Centralized VS Decentralized
disbursing

Disbursement control lies between


completely centralized and completely
decentralized decision making.
Strategic decisions made on a centralized
basis whereas tactical decisions may be
made in the field.
Rarely all decisions are made both at the
Headquarter and in the field.

Primarily Decentralized
System

Field managers make major tactical


decisions.
Payment authorization, preparation and
release are performed at the field level
Checks are drawn on a local Bank.

Primarily decentralized
Systems

Advantages
More autonomy to field managers
Relationship with the payee enhanced.
Disadvantages
Larger balances need to be kept
Disbursement float is lower
Risk of unauthorized disbursement

Primarily Centralized System

Headquarter selects drawee bank and authorizes


payment, prepares and releases payment.
Advantages
Excess balances are eliminated and can be
employed in profitable venture.
Disbursement practices are implemented at the
best interest of the company.
Unauthorized disbursement is reduced

Primarily Centralized System

Disadvantages
Autonomy of the field manager is reduced
Relationship with the payee is strained
Extra processing time may result in missed
discounts.

Cash Disbursements and the


Cash Flow Timeline

Payment system
Ethics and organizational policies
Decentralized v.s. centralized disbursements
Organizational structure
Banking system
Treasury information system
Cash flow characteristics

Payment system

Payment mechanism available to the


company, their current state of development
and relative cost, the existing clearing and
settlement mechanism, the regulatory
framework are important parts of the payment
system.

Ethics and organization


policy

Writing checks in anticipation of adequate


balances by the clearing time
Sending checks to the companys office
instead of lockbox designated by the vendor

Decentralization Vs
Centralization disbursement

Centralized disbursement allows the corporate HQ


to look after each disbursement and possibly also
initiate each disbursement.
Cash manager at Company HQ has a better view of
the company cash position and allow him to take
better decision related to availing a cash discount
and amount of transfer to the disbursement account.
Disbursement float is higher.
Elimination of duplicate disbursement account
reduces cost.
Young small company operating at single location
are centralized and deals with only one bank.

Decentralized disbursement

Decentralized disbursement allows payments


to be made by offices or individual stores.
Companies with operation spread throughout
multiple locations tend to be decentralized
Improved relationship with the supplier.
Severely hamper the efficiency and control of
disbursement accounts.

Organizational Structure

Functional areas within the organization


affect a companys disbursement system.
By organizational structure we mean firms
functional areas, their relationship, chains of
command, decision making flows and formal
and informal groups.

Treasury Information System

Capability of a companys MIS is limiting


factor on the disbursement system.
Companies are more highly automated in
payables than in any other areas
Automated system ensures that bills are paid
in time achieving substantial cost savings

Cash Flow characteristics

Cash management system create value


because cash flows are unsynchronized or
uncertain.
A company with predictable cash flow prefers
a disbursement system in which surplus are
transferred in interest bearing accounts.
Companies with unpredictable cash flows
prefer banks that link disbursement to
attractive credit facilities.

Value of disbursement float

Payor receives
invoice

Payor mails
check

Payee receives Payor deposits Payors account


check
debited
check

Disbursement
Float
Payment float

Cash Flow Timeline


Disbursement Float
Mail
Float

Processing
Float

Clearing
Float
Availability
Float

Slippage
Bank debits
payors accnt
Payee receives good funds

Payee deposits check at bank


Payee receives check
Payor puts check in the mail

Components of Disbursement
float

Disbursement float consists of


Mail float time between Payor's mailing of
the check and the payees receipt of it
Processing float the time required to
deposit the check after it has been received
Presentation/Clearing float the time
required by the banking system to return the
check and present it against the Payor's
banking account.

An example
XYZ Garments pays suppliers with paper checks. Invoices are net 30 and
XYZ usually mails check an average of 30 days from the invoice date. Mail
time from XYZ to suppliers averages 4 calendar days. Most checks are
received by lockboxes and processed on average .5 day after receipt.
Clearing time back to XYZ disbursement bank averages 1.5 days. An
average of $ 36500000 is disbursed to suppliers every year. The opportunity
cost is 10 % per annum.

The payment float associated with the disbursement systemPayment initiation time = 30.0 days
Mail time
= 4.0 days
Processing time
= 0.5 days
Presentation time
= 1.5 days
36.0 days
Value of payment float = $ 36500000/365 X .10 X 36 days = $ 360000 per year

An Example (Cont.)

If XYZ change its disbursement policies by increasing the payment


initiation time to 34 days and its presentation float to 3.5 days
Then payment float associated with the disbursement systemPayment initiation time = 34.0 days
Mail time
= 4.0 days
Processing time
= 0.5 days
Presentation time
= 3.5 days
42.0 days
Value of payment float = $ 36500000/365 X .10 X 42 days
= $ 420000 per year

Can we say now that XYZ is $ 60000 better off ?

Mail Float issue

If the postmark date is used by the payee to


determine whether an invoice has been paid
on time then mail float is considered a part of
the disbursement float.
If the receipt date is considered the valid
payment date, lengthening the mail time will
accompany a corresponding decrease in
payment initiation time.

Missed discount

Discount are allowed to encourage early


payment.
Disbursement system must consider the
possible cost of missed discount if payment
cannot be made in time.
PV concepts are useful in computing missed
discounts.

Another example

XYZ Garments pays suppliers with paper checks. Invoices are 2/10,
net 30 and XYZ usually mails check an average of 30 days from the
invoice date. Mail time from XYZ to suppliers averages 4 calendar
days. Most checks are received by lockboxes and processed on
average .5 day after receipt. Clearing time back to XYZ
disbursement bank averages 1.5 days. An average of $ 36500000 is
disbursed to suppliers every year. The opportunity cost is 10 % per
annum.
The payment float associated with the disbursement systemPayment initiation time = 30.0 days
Mail time
= 4.0 days
Processing time
= 0.5 days
Presentation time
= 1.5 days
36.0 days

Another example
(Continuation)
PV of payment float = $ 36500000
{1 + (36 X .10)/365}
= $ 36140000 with no discount
PV of payment float = $ 36500000 (1-.02)
{1 + (16 X .10)/365}
= $ 35610000 with availing discount

The difference is $ 530000 per year. This means if XYZ


misses all the discounts and pays on the net day, it loses
that amount each year.

Excess Balances in the


disbursement banks

Available balance above the level necessary


to compensate disbursing banks for its
services.
Transfers of funds may not be synchronized
with the amount presented against the
account.
Timing problem can also create excess
balance.

Elimination of excess balance


created by timing problem

Controlled disbursing Disbursement bank let the


firm know in advance the amount of check
presented so that the firm can have enough time to
transfer fund to cover the check presentment.
Zero balance account Transfer cash at the end of
the day from another account at the same bank.
The bank can arrange to sweep any balances left at
the end of the day into an interest earning account.

Transaction costs

Costs of transferring value from the


concentration account to the disbursing
account and to the cost of transferring values
to the payee.
Bank charges, third party vendor information
charges, in house expenses associated with
payment, cost of over-drafting the disbursing
accounts.

Disbursement tools

Zero Balance Accounts


Designed to remove excess balance while retaining the
advantages of separate accounts
A zero balance account has a balance of zero at the start of the
day
Its balance at the end of the day will be zero again
Money is usually moved from a master account in the same
Bank
Through the zero balance account the firm can keep less
amount of money than the summation of buffer in each
individual disbursement account.

Zero Balance Account

Funding to Zero Balance Account can also be


made from another bank.
When the master account is in the same bank then
debiting the firms account enable transfer of fund.
If the master account is in another Bank then fund
is transferred through wire.
Pseudo-zero balance account
In this the firm is notified in advance of the amount
of checks presented against the disbursement
account. So the cash management can transfer the
fund.

Advantages of Zero Balance


Account

Excess balance is reduced.


Presentation time is increased.
Facilitates decentralization by proving local
check writing authority.
Maintain funding control from the
headquarter.

Reconciliation service
Assembling a list of checks presented
against the disbursement account and
comparing the list to the checks written.
Stop Payment Services
Issued to the disbursement bank by the firm
to recall a check issued earlier.

Sweep Account
Automatic investment service for disbursement account
After clearing the excess balance above some desired level is
automatically invested in overnight investments.
It reduce excess balance and lower administrative costs.
Payable through drafts (PTD)
Appear as checks but are drawn on the issuing form instead of
disbursement bank.
The firm will have one day time to verify the authorized amount
and ensure that other conditions have been met.

Controlled Disbursing
Account

The account receives only one daily


presentment early in the morning.
The bank processes the item and notifies the
Company by the mid or late morning.
This allows the treasurer to invest the rest in
securities. It thus reduces idle balance.
Why early morning is cut off point?

Key Issues in choosing a


controlled disbursement bank

Float Used primarily for information. Availability of


clearing information early in the day. Checks
presented in the later part of the day allow
additional time.
Cost Bank charges, internal costs of maintaining
information system, charges of bank reconciliation
and balance reporting.
Time of notification When did the Bank last
receive its last presentment. It is possible to use a
second presentment if it is in the late morning.

Key Issues in choosing a


controlled disbursement bank

Funding alternative- When notified the


concentration Bank can wire transfer the
fund to the disbursement bank. But it is
expensive
Treasurers prefer to use ACH.
ACH has one day delay.

Remote Disbursing

Variation of controlled disbursing


Selection of disbursing bank will depend on how
much it extends clearing time of checks.
Objective is not only reduce excess balance but
also to extend disbursement float.
Extending the disbursement float may benefit the
firm in PV sense, delay in availability may have
adverse consequences in future price negotiation.

Dual balances

Arises when the disbursement account is


funded by DTCs that available on
disbursement account in one days but does
not clear the concentration account until a
later time.
For the tie of overlap available balances exist
in both banks at the same time.

Payee relationship

Relationship with the payee is primary


concern in managing a disbursement system.
Effort by the Payor to intentionally delay
payments may be considered unfavorable.
Measuring the costs of payee relationship is
difficult.
Strained business dealings, higher prices,
delivery holdup, damaged image, law suit,
adverse credit ratings.