Welcome to Week 11

• Brief Quiz on Chapter 18 – Short-Term

Financial Planning
• This evening's lecture – Chapter 19 (Cash
and Liquidity Management)
• Around the Bend – Chapter 21
(International Aspects and Assignment
Submission)
• Review Class
• Final Examination
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 Key Concepts and Skills
• Understand the importance of float and
how it affects the cash balances
• Know how firms manage their cash and
some of the collection, concentration, and
disbursement techniques used
• Understand the advantages and
disadvantages to holding cash and some of
the ways to invest idle cash

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 Chapter Outline
1. Reasons for Holding Cash
2. Determining the Target Cash Balance
3. Understanding Float
4. Investing Idle Cash
5. Summary and Conclusions

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 Reasons for Holding Cash
• Section 1

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Drastically Different Policies

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 Reasons for Holding Cash:
Keynes
1. Speculative motive – hold cash to take
advantage of unexpected opportunities
2. Precautionary motive – hold cash in case of
emergencies
3. Transaction motive – hold cash to pay the day-to-
day bills
• Trade-off between opportunity cost of holding
cash relative to the transaction cost of converting
marketable securities to cash for transactions
• Both 1 and 2 can relate to level of R&D intensity*
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 Question
• If short-term interest rates rise (T-Bills),
does the cost of holding cash rise or fall?
Why?  

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 Determining
the Target Cash Balance
• Section 2

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 Target Cash Balance
• A firm’s desired cash level as determined
by the trade-off between carrying costs
and shortage costs
• Adjustment costs (shortage costs) –
costs associated with holding too little cash

• Review: Flexible versus Restrictive

working capital policies...

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 Conclusion
• The target cash balance should be where
carrying costs (opportunity cost incl.) and
trading costs (adjustment costs) are
equal.  
• The higher the interest rate, the lower the
cash balance. 
• The higher the trading cost, the higher the
cash balance. 

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 Additional Considerations
• The higher the borrowing rate (Prime+), the
higher the desire for cash reserves. 
• The higher the degree of cash-flow
variability, the higher the desire for cash
reserves. 

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 Question
• How do changes in interest rates affect the
target cash balance of a firm? 

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 Understanding Float
• Section 3

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 Understanding Float
• Float – difference between cash balance
recorded in the cash account (ledger
balance) and the cash balance recorded at
the bank (available balance) *difference
due to clearing time
• Disbursement float
• Generated when a firm writes cheques
• Available balance at bank – book
balance > 0
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 BBA Inc.
• BBA Inc. writes a cheque on the 1st for
$1,000 to Acme Inc.
• Acme Inc. deposits the cheque on the
the 4th and it clears in the 6th.

• BBA Inc. has a disbursement float of $1,000 for the period from the

1st to the 6th.

• The benefit is that we could invest this money for the period.
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Understanding Float - Continued
• Collection float
• Cheques received increase book
balance before the bank credits the
account
• Available balance at bank – book
balance < 0
• Net float = disbursement float +
collection float
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 Conclusions
• Payments (Disbursements) generate
disbursement float.
• Collections (Deposits) generate collection
float.
• The difference is net float.

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 Quick Quiz I
• You have $3000 in your chequing account.
You just deposited a cheque for $2000 and
wrote a cheque for $2500.
• What is the disbursement float?
• What is the collection float?
• What is the net float?
• What is your book balance?
• What is your available bank balance?

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 Example: Measuring Float
• Size of float depends on the dollar amount and the time
delay
• Delay = mailing time (mail float) + processing delay
(processing float) + availability delay (availability float)
• Suppose you mail a cheque for $1000 and it takes 3 days
to reach its destination, 1 day to process and 1 day before
the bank will make the cash available
• What is the average daily float (assuming 30 day
months)?
• Days float*Float Size/Days in Month
• Method 1: (3+1+1)(1000)/30 = 166.67

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 Example: Cost of Float
• Cost of float – opportunity cost of not being able to
use the money
• Suppose the average daily float is $3 million with a
weighted average delay of 5 days.
• What is the total amount unavailable to earn
interest?
• 5*3 million = 15 million
• What is the NPV of a project that could reduce the
delay by 3 days if the cost is $8 million?
• Immediate cash inflow = 3*3 million = 9 million
• NPV = 9 – 8 = $1 million

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 Figure 19.3 – Cash Collection

One of the goals of float management is to try and reduce

the collection delay. There are several techniques that
can reduce various parts of the delay.
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 Ways to Reduce Float Time

• Over-the-counter systems
• Lockbox systems
• Electronic collection systems
• Credit cards
• Preauthorized payments
• Point-of-sale transfers / Debit cards
• Electronic trade payables

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 Over-the Counter
• Customers pay in person at field locations
• Location managers are responsible for
prompt deposits

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Lockboxes
• Accounts Receivables can be collected at
bank lockboxes located in key centres
around the country.
• Daily processing can enable quicker
collections.

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 Electronic Collections
• Reducing float time to near zero
• EFT, credit cards, debit cards, etc. are
reducing the costs associated with
collections.

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 Cash Disbursements
• Slowing down payments can increase
disbursement float – but it may not be
ethical or optimal to do this
• Controlling disbursements
• Zero-balance accounts
• Controlled disbursement accounts and the
“squeaky wheel” principle.

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 Investing Idle Cash
• Money market – financial instruments with
an original maturity of one-year or less
• Temporary Cash Surpluses
• Seasonal or cyclical activities – buy marketable
securities with seasonal surpluses, convert
securities back to cash when deficits occur
• Planned or possible expenditures – accumulate
marketable securities in anticipation of
upcoming expenses

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 Question
• How are electronic networks and computer
systems aiding in reducing cash collection
periods? What costs might be associated
with this?

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 Investing Idle Cash
• Section 4

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 Money Markets
• The market for short-term securities is the
money market
• A short term asset matures in 1 year or
less
• Investment dealers and commercial banks
helps firms manage short-term assets via
money markets

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Seasonal Cash Demands: Compromise
Working Capital Policy

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 Characteristics of Short-Term
Securities
• Maturity – firms often limit the maturity of
short-term investments to 90 days to avoid
loss of principal due to changing interest
rates
• Default risk – avoid investing in marketable
securities with significant default risk
• Marketability – ease of converting to cash
• Taxability – consider different tax
characteristics when making a decision
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 Interest Rate Risk
• The risk that interest rates in the market
place will change, altering the sale price of
your interest bearing security.
• Rates Up, Price Down
• Rates Down, Price Up

• This relationship is higher the longer the

maturity.

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 Dividend Capture
• Canadian corporations can receive
dividends tax free from other Canadian
corporations.
• In an effort to avoid taxes, a company
might purchase a dividend paying security
closer to the payment date (limit price risk,
but reduce taxes payable)

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 Some Types of
Short-Term Securities
• Treasury Bills (T-Bills)
• Certificates of Deposit
• Commercial Paper

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 Quick Quiz
• What are the major reasons for holding
cash?
• What is the difference between
disbursement float and collection float?
• How does a lock box system work?
• What are the major characteristics of short-
term securities?

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 Summary
• By moving cash efficiently and maximizing the
amount available for short-term investment, the
treasurer adds value to the firm
• A firm holds cash to conduct transactions
• Net float is the difference between a firm’s
available balance and its book balance
• Optimal cash levels depend on the opportunity
cost of holding cash and the uncertainty of future
cash flows
• The money market offers vehicles for parking
idle cash
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 Semester Assignment
• Please take the time to complete your
assignment for this semester.
• Thank You : )

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