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FNCE 3P93 (7)


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Geoffrey Hoover

19 Cash and Liquidity Management Key Concepts and Skills • Understand how firms manage cash • Understand float • Understand how to accelerate collections and manage disbursements • Understand the characteristics of various short-term securities 19-1 Reasons for Holding Cash 19.1 1) Speculative motive – hold cash to take advantage of unexpected opportunities 2) Precautionary motive – hold cash in case of emergencies 3) 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 19-2 T arget Cash Balance 19.2 • A firm’s desired cash level is determined by the trade-off between carrying costs and shortage costs • Adjustment costs (shortage costs) – costs associated with holding too little cash 19-3 Understanding Float 19.3 •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 cheques •Available balance at bank – book balance > 0 19-4 Understanding Float - Continued •Collection float •Cheques received increase book balance before the bank credits the account •Available balance at bank – book balance < 0 •Net float = disbursement float + collection float 19-5 Cash Collection Payment Payment Payment Cash Mailed Received Deposited Available Mailing Time Processing Delay Availability Delay Collection Delay One of the goals of float management is to try and reduce the collection delay. There are several techniques that can reduce various parts of the delay. 19-6 Example 1: Accelerating Collections – Part I • Your company does business nationally and currently all cheques are sent to the headquarters in Toronto. You are considering a lock-box system that will have cheques processed in Vancouver and Halifax. The Toronto office will continue to process the cheques 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 5000 • 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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