© 2003 The McGraw-Hill Companies, Inc. All rights reserved.
Prepared by Anne Inglis, Ryerson University
Cash and LiquidityManagement
Chapter
Nineteen
19.1
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Key Concepts and Skills
•Understand how firms manage cash
•Understand float
•Understand how to accelerate collections andmanage disbursements
•Understand the characteristics of variousshort-term securities
•Appendix: Be able to use the BAT and Miller-Orr models and understand the differentassumptions
19.2
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Chapter Outline
•Reasons for Holding Cash
•Determining the Target Cash Balance
•Understanding Float
•Investing Idle Cash
•Appendix – Cash Management Models
19.3
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Reasons for Holding Cash 19.1
•Speculative motive – hold cash to take advantage ofunexpected opportunities
•Precautionary motive – hold cash in case ofemergencies
•Transaction motive – hold cash to pay the day-to-daybills
•Trade-off between opportunity cost of holding cashrelative to the transaction cost of convertingmarketable securities to cash for transactions
19.4
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Target Cash Balance 19.2
•A firm’s desired cash level as determined bythe trade-off between carrying costs andshortage costs
•Adjustment costs (shortage costs) – costsassociated with holding too little cash
19.5
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Understanding Float 19.3
•Float – difference between cash balance recorded inthe cash account and the cash balance recorded at thebank
•Disbursement float
–Generated when a firm writes cheques
–Available balance at bank – book balance > 0
•Collection float
–Cheques received increase book balance before thebank credits the account
–Available balance at bank – book balance < 0
•Net float = disbursement float + collection float
19.6
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Quick Quiz I
•You have $5000 in your checking account.You just received a check of $2000 and wrotea check 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?
19.7
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Example: Measuring Float
•Size of float depends on the dollar amount and thetime delay
•Delay = mailing time + processing delay +availability delay
•Suppose you mail a check for $1000 and it takes 3days to reach its destination, 1 day to process and 1day before the bank will make the cash available
•What is the average daily float (assuming 30 daymonths)?
–Method 1: (3+1+1)(1000)/30 = 166.67
–Method 2: (5/30)(1000) + (25/30)(0) = 166.67
19.8
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Example: Cost of Float
•Cost of float – opportunity cost of not beingable to use the money
•Suppose the average daily float is $3 millionwith a weighted average delay of 5 days.
–What is the total amount unavailable to earninterest?
•5*3 million = 15 million
–What is the NPV of a project that could reduce thedelay by 3 days if the cost is $8 million?
•Immediate cash inflow = 3*3 million = 9 million
•NPV = 9 – 8 = $1 million
19.9
Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved.
Cash Collection
Payment PaymentPayment Cash
Mailed ReceivedDeposited Available
Mailing Time
Processing Delay
Availability Delay
Collection Delay
One of the goals of float management is to try and reduce thecollection delay. There are several techniques that can reducevarious parts of the delay.