9780273713654 pp09

9.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Chapter 9Chapter 9
Cash and MarketableCash and Marketable
SecuritiesSecurities
ManagementManagement

1. List and explain the motives for holding cash.
2. Understand the purpose of efficient cash management.
3. Describe methods for speeding up the collection of accounts receivable
and methods for controlling cash disbursements.
4. Differentiate between remote and controlled disbursement, and discuss
any ethical concerns raised by either of these two methods.
5. Discuss how electronic data interchange (EDI) and outsourcing each
relates to a company’s cash collections and disbursements
6. Identify the key variables that should be considered before purchasing
any marketable securities.
7. Define the most common money-market instruments that a marketable
securities portfolio manager would consider for investment.
8. Describe the three segments of the marketable securities portfolio and
note which securities are most appropriate for each segment and why.
After Studying Chapter 9,After Studying Chapter 9,
you should be able to:you should be able to:

• Motives for Holding Cash
• Speeding Up Cash Receipts
• S-l-o-w-i-n-g D-o-w-n
Cash Payouts
• Electronic Commerce
Securities ManagementSecurities Management

• Outsourcing
• Cash Balances to Maintain
• Investment in Marketable
Securities
Securities ManagementSecurities Management

Transactions MotiveTransactions Motive – to meet
payments arising in the ordinary
course of business
Speculative MotiveSpeculative Motive – to take
advantage of temporary opportunities
Precautionary MotivePrecautionary Motive – to maintain a
cushion or buffer to meet unexpected
cash needs
Motives for Holding CashMotives for Holding Cash

Collections Disbursements
Marketable securities
investment
Control through information reporting
= Funds Flow = Information Flow
Cash Management SystemCash Management System

• Expedite preparing and mailing the
invoice
• Accelerate the mailing of payments from
customers
• Reduce the time during which payments
received by the firm remain uncollected
Collections
Speeding UpSpeeding Up
Cash ReceiptsCash Receipts

Collection FloatCollection Float: Total time between the mailing
of the check by the customer and the availability
of cash to the receiving firm.
ProcessingProcessing
FloatFloat
AvailabilityAvailability
FloatFloat
MailMail
FloatFloat
Deposit FloatDeposit Float
Collection FloatCollection Float

Mail FloatMail Float: Time the check is in the mail.
CustomerCustomer
mails checkmails check
FirmFirm
receives checkreceives check
Mail FloatMail Float

Processing FloatProcessing Float: Time it takes a company
to process the check internally.
FirmFirm
deposits checkdeposits check
FirmFirm
receives checkreceives check
Processing FloatProcessing Float

Availability FloatAvailability Float: Time consumed in clearing
the check through the banking system.
FirmFirm
deposits checkdeposits check
Firm’s bankFirm’s bank
account creditedaccount credited
Availability FloatAvailability Float

Deposit FloatDeposit Float: Time during which the check
received by the firm remains uncollected funds.
Processing FloatProcessing Float Availability FloatAvailability Float
Deposit FloatDeposit Float

Accelerate preparation and
mailing of invoices
• computerized billing
• invoices included with shipment
• invoices are faxed
• advance payment requests
• preauthorized debits
Earlier BillingEarlier Billing

Preauthorized debitPreauthorized debit
The transfer of funds from a payor’s
bank account on a specified date to
the payee’s bank account; the
transfer is initiated by the payee
with the payor’s advance
authorization.
Preauthorized PaymentsPreauthorized Payments

Traditional LockboxTraditional Lockbox
A post office box maintained by a firm’s bank
that is used as a receiving point for customer
remittances.
Electronic LockboxElectronic Lockbox
A collection service provided by a firm’s bank
that receives electronic payments and
accompanying remittance data and
communicates this information to the
company in a specified format.
Lockbox SystemsLockbox Systems

• Customers are instructed to mail their
remittances to the lockbox location.
• Bank picks up remittances several times
daily from the lockbox.
• Bank deposits remittances in the customers
account and provides a deposit slip with a
list of payments.
• Company receives the list and any additional
mailed items.
* Based on the traditional lockbox system
Lockbox Process*Lockbox Process*

DisadvantageDisadvantage
Cost of creating and maintaining a
lockbox system. Generally, not
advantageous for small remittances.
AdvantageAdvantage
Receive remittances sooner which
reduces processing float.
Lockbox SystemLockbox System

Compensating BalanceCompensating Balance
Demand deposits maintained by a firm
to compensate a bank for services
provided, credit lines, or loans.
Cash ConcentrationCash Concentration
The movement of cash from lockbox or
field banks into the firm’s central cash
pool residing in a concentration bank.
Concentration BankingConcentration Banking

Reduces availability float associated
with check clearing.
Accounts Receivable ConversionAccounts Receivable Conversion
A process by which paper checks are
converted into ACH debits at lockboxes
or other collection sites.
So what is the Benefit of ARCs?So what is the Benefit of ARCs?
Collections ImprovementsCollections Improvements

Check Clearing for the 21Check Clearing for the 21stst
Century ActCentury Act
“Check 21”: US, Federal law that facilitates
electronic check exchange by enabling
banks to exchange check image files
electronically and, where necessary, to
create legally equivalent paper “substitute
checks” from images for presentment to
banks that have not agreed to accept
checks electronically.

Check 21Check 21
• Driven by September 11, 2001 attacks
• Meant to foster innovation and encourage the move from
paper checks to electronic payment processing to create
cost and time benefits for financial institutions
• Requires banks to accept substitute checks (a paper
copy of an electronic image of both sides of the original
check) as the legal equivalent of the original paper check
• Cleared the legal path to allow ‘remote deposit capture’

• Improves control over inflows and
outflows of corporate cash.
• Reduces idle cash balances to a
minimum.
• Allows for more effective investments
by pooling excess cash balances.
Moving cash balances toMoving cash balances to
a central location:a central location:
Concentration BankingConcentration Banking

Definition: A non-negotiable check
payable to a single company
account at a concentration
bank.
Funds are not immediately availableFunds are not immediately available
upon receipt of the DTC.upon receipt of the DTC.
(1) Depository Transfer Check (DTC)(1) Depository Transfer Check (DTC)
Concentration ServicesConcentration Services
for Transferring Fundsfor Transferring Funds

Definition: An electronic version of the
depository transfer check
(DTC).
(1) Electronic check image version ofElectronic check image version of
the DTC.the DTC.
(2) Cost is not significant and is(2) Cost is not significant and is
replacing DTC.replacing DTC.
(2) Automated Clearinghouse(2) Automated Clearinghouse
(ACH) Electronic Transfer(ACH) Electronic Transfer

Definition: A generic term for electronic
funds transfer using a two-
way communications system,
like Fedwire.
Funds are available upon receipt of theFunds are available upon receipt of the
wire transfer. Much more expensive.wire transfer. Much more expensive.
(3) Wire Transfer(3) Wire Transfer

• “Playing the Float”
• Control of Disbursements
• Payable through Draft (PTD)
• Payroll and Dividend
Disbursements
• Zero Balance Account (ZBA)
• Remote and Controlled Disbursing
S-l-o-w-i-n-g D-o-w-nS-l-o-w-i-n-g D-o-w-n
Cash PayoutsCash Payouts

You write a check today, which is subtracted from
your calculation of the account balance. The check
has not cleared, which creates float. You can
potentially earn interest on money that you have
“spent.”
Net FloatNet Float -- The dollar difference between
the balance shown in a firm’s (or
individual’s) checkbook balance and the
balance on the bank’s books.
““Playing the Float”Playing the Float”

SolutionSolution::
Centralize payables into a single (smaller
number of) account(s). This provides better
control of the disbursement process.
Firms should be able toFirms should be able to::
1. shift funds quickly to banks from which
disbursements are made.
2. generate daily detailed information on
balances, receipts, and disbursements.
Control of DisbursementsControl of Disbursements

• Delays the time to have funds on depositDelays the time to have funds on deposit
to cover the draft.to cover the draft.
• Some suppliers prefer checks.Some suppliers prefer checks.
• Banks will impose a higher service chargeBanks will impose a higher service charge
due to the additional handling involved.due to the additional handling involved.
Payable Through Draft (PTD)Payable Through Draft (PTD)::
A check-like instrument that is drawn against the
payor and not against a bank as is a check. After
a PTD is presented to a bank, the payor gets to
decide whether to honor or refuse payment.
Methods of ManagingMethods of Managing
DisbursementsDisbursements

• Many times a separate account is set up toMany times a separate account is set up to
handle each of these types of disbursements.handle each of these types of disbursements.
• A distribution schedule is projected based onA distribution schedule is projected based on
past experiences. [See the next slide]past experiences. [See the next slide]
• Funds are deposited based on expected needs.Funds are deposited based on expected needs.
• Minimizes excessive cash balances.Minimizes excessive cash balances.
Payroll and Dividend DisbursementsPayroll and Dividend Disbursements
The firm attempts to determine when payroll and
dividend checks will be presented for collection.

F M T W H F M and after
(Payday)(Payday)
PercentofPercentof
PayrollCollectedPayrollCollected
100%
75%
50%
25%
0%
The firm may plan on
payroll checks being
presented in a similar
pattern every pay period.
Percentage of PayrollPercentage of Payroll
Checks CollectedChecks Collected

• Eliminates the need to accuratelyEliminates the need to accurately
estimate each disbursement account.estimate each disbursement account.
• Only need to forecast overall cash needs.Only need to forecast overall cash needs.
Zero Balance Account (ZBA)Zero Balance Account (ZBA)::
A corporate checking account in which a zero
balance is maintained. The account requires a
master (parent) account from which funds are
drawn to cover negative balances or to which
excess balances are sent.

Example:Example: A Vermont business pays a Maine
supplier with a check drawn on a bank in Montana.
ThisThis maymay stress supplier relations, and raises ethicalstress supplier relations, and raises ethical
issues.issues.
Remote DisbursementRemote Disbursement – A system in which
the firm directs checks to be drawn on a bank
that is geographically remote from its customer
so as to maximize check-clearing time.
This maximizes disbursement float.This maximizes disbursement float.
Remote andRemote and
Controlled DisbursingControlled Disbursing

Late check presentments are minimal, whichLate check presentments are minimal, which
allows more accurate predicting ofallows more accurate predicting of
disbursements on a day-to-day basis.disbursements on a day-to-day basis.
Controlled DisbursementControlled Disbursement – A system in
which the firm directs checks to be drawn
on a bank (or branch bank) that is able to
give early or mid-morning notification of
the total dollar amount of checks that will
be presented against its account that day.
Remote andRemote and
Controlled DisbursingControlled Disbursing

Messaging systems can be:
1. UnstructuredUnstructured – utilize technologies
such as faxes and e-mailsfaxes and e-mails
2.2. StructuredStructured – utilize technologies suchsuch
asas electronic data interchange (EDI)electronic data interchange (EDI)..
Electronic CommerceElectronic Commerce – The exchange of
business information in an electronic (non-
paper) format, including over the Internet.
Electronic CommerceElectronic Commerce

Electronic Data InterchangeElectronic Data Interchange – The
movement of business data electronically
in a structured, computer-readable format.
EDIEDI
Electronic Funds Transfer (EFT)Electronic Funds Transfer (EFT)
Financial EDI (FEDI)Financial EDI (FEDI)
Electronic DataElectronic Data
Interchange (EDI)Interchange (EDI)

Electronic Funds Transfer (EFT)Electronic Funds Transfer (EFT) – the electronic
movements of information between two
depository institutions resulting in a value
(money) transfer.
EDIEDI
SubsetSubset
Electronic Funds Transfer (EFT)Electronic Funds Transfer (EFT)
Society of Worldwide Interbank
Financial Telecommunications (SWIFT)
Clearinghouse Interbank Payments
System (CHIPS)
Electronic FundsElectronic Funds
Transfer (EFT)Transfer (EFT)

EFT RegulationEFT Regulation
In January 1999, a regulation that required
ALL federal government payments be made
electronically.* This:
• provides more security than paper checks and
• is cheaper to process for the government.
* Except tax refunds and special waiver situations
Electronic FundsElectronic Funds
Transfer (EFT)Transfer (EFT)

Financial EDIFinancial EDI – The movement of financially
related electronic information between a
company and its bank or between banks.
Examples includeExamples include:
Lockbox remittance information
Bank balance information
EDIEDI
SubsetSubset

CostsCosts
• Computer hardware and
software expenditures
• Increased training costs
to implement and utilize
an EDI system
• Additional expenses to
convince suppliers and
customers to use the
electronic system
• Loss of float
BenefitsBenefits
• Information and payments
move faster and with
greater reliability
• Improved cash
forecasting and cash
management
• Customers receive faster
and more reliable service
• Reduction in mail, paper,
and document storage
costs
Costs and Benefits of EDICosts and Benefits of EDI

1. Reducing and controlling operating
costs
2. Improve company focus (close 2nd
)
3. Freeing resources for other purposes
* The Outsourcing Institute, 2005
OutsourcingOutsourcing – Subcontracting a certain
business operation to an outside firm,
instead of doing it “in-house.”
Why might a firm outsource?*Why might a firm outsource?*
OutsourcingOutsourcing

Business Process Outsourcing (BPO)Business Process Outsourcing (BPO)
A form of outsourcing in which the
entire business process is handed over
to a third-party service provider
• Entire function such as accounting might
be handed over to the BPO
• Typically found in low labor cost countries
• Many are owned by large multinationals
OutsourcingOutsourcing

The optimal level of cash shouldThe optimal level of cash should
be the larger of:be the larger of:
(1) The transaction balances required
when cash management is
efficient.
(2) The compensating balance
requirements of commercial
banks.
Cash Balances to MaintainCash Balances to Maintain

Note regarding the managementNote regarding the management
of marketable securities.of marketable securities.
• Marketable Securities are
shown on the balance sheet as
“Short-term Investments”
Investment inInvestment in
Marketable SecuritiesMarketable Securities

Ready CashReady Cash
Segment (R$)Segment (R$)
Optimal balance ofOptimal balance of
marketable securitiesmarketable securities
held to take care ofheld to take care of
probable deficienciesprobable deficiencies
in the firm’s cashin the firm’s cash
account.account.
R$
F$
C$
The MarketableThe Marketable
Securities PortfolioSecurities Portfolio

Controllable CashControllable Cash
Segment (C$)Segment (C$)
Marketable securitiesMarketable securities
held for meetingheld for meeting
controllablecontrollable
(knowable) outflows,(knowable) outflows,
such as taxes andsuch as taxes and
dividends.dividends.
R$
F$
C$

Free CashFree Cash
Segment (F$)Segment (F$)
““Free” marketableFree” marketable
securities (that is,securities (that is,
available for as yetavailable for as yet
unassignedunassigned
purposes).purposes).
R$
F$
C$

Marketability (or Liquidity)Marketability (or Liquidity)
The ability to sell a significant volume of
securities in a short period of time in the
secondary market without significant price
concession.
SafetySafety
Refers to the likelihood of getting back the
same number of dollars you originally
invested (principal).
Variables in MarketableVariables in Marketable
Securities SelectionSecurities Selection

MaturityMaturity
Refers to the remaining life of the
security.
Interest Rate (or Yield) RiskInterest Rate (or Yield) Risk
The variability in the market price of a
security caused by changes in
interest rates.
Variables in MarketableVariables in Marketable
Securities SelectionSecurities Selection

• Treasury Bills (T-bills)Treasury Bills (T-bills):: Short-term,
non-interest bearing obligations of
the US Treasury issued at a discount
and redeemed at maturity for full face
value. Minimum $100 amount and
$100 increments thereafter.
Money Market InstrumentsMoney Market Instruments
All government securities and short-term
corporate obligations. (Broadly defined)
Common MoneyCommon Money
Market InstrumentsMarket Instruments

BEY = [ (1000 – 990) / (990) ] *[ 365 / 91 ]
BEY = 4.05%
T-Bills and Bond EquivalentT-Bills and Bond Equivalent
Yield (BEY) Method:Yield (BEY) Method:
BEY = [ (FA – PP) / (PP) ] *[ 365 / DM ]
• FA: face amount of security
• PP: purchase price of security
• DM: days to maturity of security
A $1,000, 13-week T-bill is purchased for $990 – what is
its BEY?

EAY = (1 + [.0405/(365 / 91)])365/91
- 1
EAY = 4.11%
T-Bills and EquivalentT-Bills and Equivalent
Annual Yield (EAY) Method:Annual Yield (EAY) Method:
EAY = (1 + [ BEY / (365 / DM) ] )365/DM
- 1
• BEY: bond equivalent yield from the previous slide
• DM: days to maturity of security
Calculate the EAY of the $1,000, 13-week T-bill purchased
for $990 described on the previous slide?

• Treasury BondsTreasury Bonds:: Long-term (more
than 10 years’ original maturity)
obligations of the US Treasury.
• Treasury NotesTreasury Notes:: Medium-term (2-
10 years’ original maturity)
obligations of the US Treasury.

• Bankers’ Acceptances (BAs)Bankers’ Acceptances (BAs):: Short-
term promissory trade notes for which
a bank (by having “accepted” them)
promises to pay the holder the face
amount at maturity.
• Repurchase Agreements (RPs; repos)Repurchase Agreements (RPs; repos)::
Agreements to buy securities (usually
Treasury bills) and resell them at a
higher price at a later date.

• European Commercial PaperEuropean Commercial Paper:: See above,
except maturities extend to one year and
more active secondary market.
• Commercial PaperCommercial Paper:: Short-term, unsecured
promissory notes, generally issued by large
corporations (unsecured IOUs). The largest
dollar-volume instrument in US. Maturities
don’t exceed 270 days to preclude SEC
registration.

• Federal Agency SecuritiesFederal Agency Securities:: Debt securities
issued by federal agencies and government-
sponsored enterprises (GSEs). Examples:
FFCB, FNMA, and FHLMC.
• Negotiable Certificate of DepositNegotiable Certificate of Deposit:: A large-
denomination investment in a negotiable time
deposit at a commercial bank or savings
institution paying a fixed or variable rate of
interest for a specified period of time.

• Money Market Preferred StockMoney Market Preferred Stock::
Preferred stock having a dividend rate
that is reset at auction every 49 days.
• EurodollarsEurodollars:: A US dollar-denominated
deposit – generally in a bank located
outside the United States – not subject
to US banking regulations

Ready CashReady Cash
Segment (R$)Segment (R$)
Safety and ability toSafety and ability to
convert to cash isconvert to cash is
most important.most important.
SelectSelect USUS
TreasuriesTreasuries for thisfor this
segment.segment.
R$
F$
C$
Selecting Securities forSelecting Securities for
the Portfolio Segmentsthe Portfolio Segments

Controllable CashControllable Cash
Segment (C$)Segment (C$)
Marketability lessMarketability less
important. Possiblyimportant. Possibly
match time needs.match time needs.
May selectMay select CDs,CDs,
repos, BAs, eurosrepos, BAs, euros forfor
this segment.this segment.
R$
F$
C$

Free CashFree Cash
Segment (F$)Segment (F$)
Base choice on yieldBase choice on yield
subject to risk-returnsubject to risk-return
trade-offs.trade-offs.
Any money marketAny money market
instrumentinstrument may bemay be
selected for thisselected for this
segment.segment.
R$
F$
C$

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