Basic Cash Management Process Essay Example for Free

Basic Cash Management Process Essay all(prenominal) company puke be viewed as a gold pool into which funds move from divers(a) sources. Several techniques ar used to speed the collection of such funds. Conversely, capital flows out of the pool for payables and another(prenominal) disbursement reasons. An important aspect of currency management is to control tightly both cash inflows and outflows. When cash inflows exceed cash outflows, surplus cash builds up. This surplus can be used to repay debts or for investment in marketable securities. Alternatively, when outgoing funds exceed the inflow, the firm must raise money by borrowing or by selling some marketable securities. THE CONCEPT OF FLOATA cash managers job is to make payments to others as slowly as possible and to convert into cash or clear payments trustworthy from others as quickly as possible. The reason is foul up, the most important element of cash management. Float is the amount of uncollected funds movi ng through the financial transfer frame. It trys up as the difference between the balance shown on a firms schooling account and the balance on the banks books. For example, suppose a firm writes, on average, $100,000 of checks daily. If it takes four days for checks to clear and be deducted from the firms bank balance, the firms own books provide show a cash balance that is $400,000 less than the banks records indicate. The firm has the use of these funds, called disbursement burn out, as long as this situation persists.On the other hand, the firm loses the use of check-clearing mishandle one component of collection drift on the checks that it has deposited in its account but that have not yet cleared. Suppose the firm deposits $90,000 in checks every day, and these checks clear in three days on average. The firms books then show cash balances that are $270,000 larger than the banks books indicate. Thus, the firms net float the difference between its $400,000 disbursemen t float and its $270,000 check-clearing float is $130,000. This means that the firms developed cash balance is $130,000 greater than its recorded cash balance. The firm can invest or other spend these excess funds. The float on an individual item can be mensural in dollar-days and is calculated as the amount of the check multiplied by the number of days of delay until that check clearsAlternatively, the average daily float can be calculated as the average daily revenue multiplied by the average delay in collecting each dollar. The average delay in collecting a dollar equals the total dollar-days of float divided by the total amount received during the period or Average DelayThe existence of float lies at the core of every system designed to accelerate, decelerate, or control corporate funds. By reducing collection float, the corporate treasurer can accelerate cash flow and enhance the return on current assets. Similarly, corporate cash flow may be improved by increasing disburs ement float.The value of decreasing collection float or increasing disbursement float is tied to the opportunity cost of funds. It can be measured as Value of Float = Dollar Amount of Float quantify Time meters involution Rate For example, suppose a firm can reduce the collection time on $5 million of receivables by three days. Assuming that it will invest this money at an annual pertain rate of 10 percent, it will earn interest at a rate of .10/365 per day on the $5 million. Therefore, the value of a three-day simplification in collection float is $5,000,000 times 3 times 0.10/365 = $4,109.59If collections ordinarily average $5 million daily and the company managed to reduce the float permanently by three days, it would then be able to free up $15 million in functional capital. At 10 percent interest, this reduction in float is worth $1.5 million ($5,000,000 times 3 times .10) annually. Using a 10 percent discount rate, the present value of this permanent reduction in float i s $15 million ($1,500,000/.10). Reworking this example with a different interest rate, say 6 percent, reveals that if the company can permanently free up $15 million in working capital, its shareholders will be $15 million richer ($900.000/.6), regardless of the interest rate. In other words, the value created by a permanent reduction in float is independent of the interest rate.Collection FloatCollection float is the time that receivables spend in the process of being collected. It consists of the following four elements1.Invoicing float is the interval from the time a company creates an invoice and mails it to the customer until the customer places the payment in the mail. During this phase of the collection cycle, the cash manager has no control over the funds. 2.Mail float, the next phase in the cycle, is the time taken by the U.S. Postal Service to deliver the customers check. 3.Having received payment, the company experiences processing float, the flow of the check through the companys history system on its way to be deposited. 4.Finally, there is check-clearing float. This is the time it takes to clear each check deposited. Invoicing float may be reduced only by changing the payment terms. The other three types of float are controllable. A.2 discusses the various means to accelerate the collection of funds. Exhibit A.1 illustrates the various types of collection float.