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The Management of Cash and Marketable Securities

©2006 Thomson/South-Western

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Introduction

This chapter reviews the various cash management decisions made by financial managers.

The financial managers must consider the risk vs. return trade-offs characteristic of these decisions.

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Cash and Marketable Securities Are the most liquid of a firm’s assets

Cash consists of currency and deposits in

checking accounts.

Marketable securities consist of S-T

investments made with idle cash.

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Cash Management Function Concerned with determining

The optimal size of a firm’s liquid asset balance

The most efficient methods of controlling the collection and disbursement of cash

The appropriate types and amounts of

S-T investments

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Cash Management Decisions

Must consider the risk versus expected return trade-offs from alternative policies

Check out cash management at this Web site:http://www.bankofamerica.com/

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Reasons for Holding Liquid Assets Transactions

Precautionary

Future requirements

Speculative

Compensating balances

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Cash Budget

Required because cash inflows and outflows are seldom synchronized

First step in cash management Show forecasted receipts and disbursements Show forecast of any cumulative shortages or

surpluses Series of cash budgets

Daily Weekly Monthly

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Bank Services

Maintenance of disbursement and payroll accounts

Collection of deposits Lines of credit Term loans Handling of dividend payments Registration and transfer of stock Supply credit information Consulting advice

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Cash Management

Determination of the optimal size Compensating balance requirements establish

lower limit Holding excess liquid assets results in an

opportunity cost Inadequate liquid balances result in shortage

costs Missing cash discounts Deterioration of the firm’s credit rating Higher interest costs Risk of insolvency

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Cash CollectionOpportunities to increase the available cash balance Float Decentralized collection system Lockbox Wire transfers Depository transfer check (DTC) Electronic depository transfer check (EDTC) Courier service Preauthorized check (PAC)

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Float

Positive Balance at bank is greater than the firm’s balance

Negative Firm shows a higher balance than bank’s

Management's goal Speed collection/slow disbursements

Components of float Mail float Processing float Check clearing float

A number of systems can be used to reduce the float

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Lockbox System

Local bank Empties the box Deposits payments in the firm’s account Makes a report of the payments

Firm makes disbursements of funds in excess of compensating balances

Involves significant fees More beneficial for small number of larger

deposits Evaluation involves comparison of costs versus

benefits of faster collection

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Setting Up Lockboxes

This Web site will set up and operate a lock box system:http://www.firstunion.com/index.html

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Slowing Cash Disbursements Zero-balance system

Transfers cash in the exact amount required for the cleared checks

Drafts Deposit funds only after the draft is presented

for payment. Synchronize deposits with check

clearings Requires accurate estimates of float

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Cash Management for Small Firms Less-extensive access to capital markets Cash shortage may be more expensive to

rectify. Many small businesses are rapidly

growing. May have low balances of cash resources

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Choosing Marketable Securities

Default risk Lowest on U.S. Treasury securities Risk and expected return inversely related

Marketability Sold quickly without significant price concession

Maturity Shorter maturities have less risk of price

fluctuation Rate of return

Least important consideration

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Marketable Securities

T-Bills Treasury Issues

Fed Agency

S-T Municipal Securities

Negotiable CDs

Commercial Paper

Repurchase Agreements

Banker’s Acceptance

Eurodollar Deposits

Money Market P/S

Money Market Mutual Funds

Money market Accounts

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Multinational Corporation (MNC) Difficult and costly currency transactions Cash transfer facilities Greater variety of investment opportunities Usually have centralized cash management Tracks cash balances around the world Identifies best sources of S-T borrowing/ lending Use Multilateral netting

Cross-border transactions are netted off to minimize costly transactions and misdirected funds.