Because learning changes everything.

Corporate Finance
Thirteenth Edition
Stephen A. Ross / Randolph W. Westerfield / Jeffrey F.Jaffe /
Bradford D. Jordan

Chapter 27

Cash Management

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 Key Concepts and Skills
• Understand the importance of float and how it affects the
cash balance.
• Understand how to accelerate collections and manage
disbursements.
• Understand the advantages and disadvantages of holding
cash and some of the ways to invest idle cash.

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 Chapter Outline
27.1 Reasons for Holding Cash.
27.2 Understanding Float.
27.3 Cash Collection and Concentration.
27.4 Managing Cash Disbursements.
27.5 Investing Idle Cash.

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 27.1 Reasons for Holding Cash
Speculative motive: hold cash to take advantage of
unexpected opportunities.
Precautionary motive: hold cash in case of emergencies.
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.

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 27.2 Understanding Float
Float: difference between cash balance recorded in the cash
account and the cash balance recorded at the bank.
Disbursement float
• Generated when a firm writes checks.
• Available balance at bank − Book balance > 0.

Collection float
• Checks 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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 Example: Types of Float
You have $3,000 in your checking account. You just
deposited a check of $2,000 and wrote a check for $2,500.
• What is the disbursement float?
• What is the collection float?
• What is the net float?
• What is your book balance?
• What is your available balance?

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 Example: Measuring Float
Size of float depends on the dollar amount and the time
delay.
Delay = Mailing time + Processing delay + Availability delay.
Suppose you mail a check each month for $1,000 and it
takes 3 days to reach its destination, 1 day to process, and 1
day before the bank makes the cash available.
What is the average daily float (assuming 30 days per
month)?
(3  1  1)($1000)
Method 1:  $166.67
30
 5   25 
Method 2:   ($1000)    ($0)  $166.67
 30   30 
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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 million − 8 million = $1 million.

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 27.3 Cash Collection and Concentration

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

collection delay. There are several techniques that can
reduce various parts of the delay.

Access the text alternative for slide images

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 Example: Accelerating Collections
Your company does business nationally, and currently, all
checks are sent to the headquarters in Tampa, F L. You are
considering a lockbox system that will have checks
processed in Phoenix, St. Louis, and Philadelphia. The
Tampa office will continue to process the checks it receives
in-house.
• Collection time will be reduced by 2 days on average.
• Daily interest rate on T-bills = .01%.
• Average number of daily payments to each lockbox is 5,000.
• Average size of payment is $500.
• The processing fee is $.10 per check plus $10 to wire funds to
a centralized bank at the end of each day.

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 Example: Accelerating Collections
Benefits
• Average daily collections = 3(5,000)($500) = $7,500,000.
• Increased bank balance = 2($7,500,000) = $15,000,000.
Costs
• Daily cost = .1($15,000) + 3($10) = $1,530.

$1,530
Present value of daily cost   $15,300,000
.0001

• NPV = $15,000,000 − 15,300,000 = −$300,000.

• The company should not accept this lockbox proposal.

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 27.4 Managing Cash Disbursements
Slowing down payments can increase disbursement float.
• But it may not be ethical or optimal to do this!

Controlling disbursements.
• Zero-balance account.
• Controlled disbursement account.

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 27.5 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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 Figure 27.6 Seasonal Cash Demands

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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 assets to cash.
Taxability: consider different tax characteristics when making
a decision.

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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 lockbox system work?
What are the major characteristics of short-term securities?

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