Other Ways of Controlling Cash Flows

Synchronizing Cash Flows

-Synchronization of cash flow is an important cash management technique, as it can reduce the
required cash balance and increase a firm's profitability. This is a process in which the cash
inflows match with the outflows. It is highly dependent on an accurate forecast of inflows and
outflows. Therefore, there will be fewer borrowings, lower interest expense, and maximized
profits.

Floats on Disbursements
-The float is money within the banking system that is briefly counted twice due to time gaps in
registering a deposit or withdrawal. These time gaps are usually due to the delay in processing
paper checks. Floats are the differences between the company’s book balance and bank
account balance in any period. These floats exist when a company issues its own check and
sends it to the payee company.
The checks are cleared depending on the type of check issued;
On-Us check (Checks drawn on an account held by your institution) take a day, Local checks
take three days, Regional checks take five to seven days, and out-of-town checks take about
seven to ten days depending on their locations.
A float can be classified into three categories:
• Mail Float - It is from the time the check is issued until the time the check is received by
the payee.
• Processing Float – It is from the time the check is received by the payee until the time it
is deposited in the payee’s bank account.
• Clearing Float – It is from the date the check is deposited until the date the check is
cleared and made available for use.

Accelerating Collection of Funds by Reducing Collection

Float
1. Collecting Center or Agent. A float can be reduced by strategically locating a collection
near the customer. The collection center can be a company providing a collection service, or
a bank where payments are made directly to the company’s account.
Ex: GEM Corporation has an agreement with Security Bank Corp (SBC) to collect P3,000,000 a
day in exchange for a compensating balance of P500,000. The firm, with a significant increase
in its customer in the area, is thinking of cancelling the agreement and dividing the service
provided by SBC with China Bank, Inc. (CBI).
With this plan, SBC will handle the collection of P2,000,000 with a compensating balance of
P800,000. On the other hand, CBI bank will handle the other P1,000,000 collection in exchange
for a compensating balance of P400,000. With the planned arrangement with the two banks to perform
the collection, the firm is expecting to reduce the collection period by one day. The firm’s rate of return is
7%.

What is the amount of incremental income or loss if GEM will pursue the division of service between SBC
and CBI?

PRESENT PROPOSAL
SBC SBC
Daily collection
Daily Collection P2,000,000
P3,000,000
Compensating Balance P800,000
Compensating
balance CBI

P500,000 Daily collection P1,000,000

Compensating balance P400,000

Amount of cash collection/day
No. of days freed on the collection
Amount of cash freed
Increase in compensating balance
Increase in cash flow
Rate of Return
Incremental Income
P3,000,000
Reduce collection period by 1 day
× 1
Firm’s rate of return = 7%
P3,000,000
- 600,000 Analysis: The amount of increase in compensating balance is
P2,400,000 from the average of the total balance of compensating
balance of SBC and CBI. The increase in cash flow is could be
× 7.00%
invested in other opportunities and it is beneficial to pursue
P168,000 the service of 2 collecting centers or agent which are the
SBC and CBI. But if the incremental income is negative, it
means that we must should maintain on what is our present
scenario which is through SBC.

2. Lockbox system. It is an arrangement of several lockboxes that are strategically placed

near geographic clusters of company customers, so that aggregate mail time the customers
to the lockboxes from is minimized. It is a system that gives a company a “P.O. box number”
address. All collections made by the customer will be directed to a P.O. box that is rented in
a postal office.
 Ex: ABC company is a retail mail order that currently uses a central collection system that
requires all checks to be sent to its headquarters. An average of 6 days is required for
mailed checks to be received, 3 days to process them and 2 days for the checks to clear
through its bank. A proposed lockbox system would reduce the mailing and processing time
to 2 days and the check clearing time to 1 day. An entity has an average daily collection of
P150,000.
How much would be the increase in the average cash balance if the company adopts the
lockbox system?

Present Proposed Lockbox Difference

Mail Float (days) 6 2 4
Processing Float 3 2 1
(days)
Clearing float (days) 2 1 1
Total Float (days) 11 5 6
× Average Daily P150,000
Collection
Increase in Average P900,000
cash balance

Analysis: We have a present in terms of days which total in 11 days, and then, the proposed
lockbox with the total of 5 days. Now, we will deduct the no. present days to the proposed
lockbox in terms of days and the total reduction in the days would be 6 times the P150,000 the
average daily collection. So, the increase in average cash balance would be equal to P900,000.
The P900,000 could be re-invested by the company.

3. Concentration banking. It is the practice of shifting the funds in a set of bank accounts into
an investment account, from which the funds can be more efficiently invested. A company
doing business over a wide geographically area normally maintains several accounts in
different banks. The accounts are used for several reasons, including payroll of employees
in the different parts of the country or region, payments to the suppliers, receipts of
collections from customers, and other transactions that may be accounted for as normal
operations of the company.

One good example is Remittances made to Social Security System (SSS), whose main
account is being maintained in the RCBC head office in Makati. This government agency has
numerous accounts in different branches of RCBC all over the country.
Extending Cash Disbursements
Cash management has two sides: the cash inflow and the cash outflow. The cash inflow
or the acceleration of funds to support company operations and to gain additional
income on the cash freed-up. The cash outflow, is concerned with how cash
disbursements can be extended from the time the billing statement is received.

Stretching Payables is an obvious way of extending cash disbursements. At a certain

point, after a series of contraction of the supply of money, the suppliers will no longer
tolerate the company’s practice, which will result in the cut-off of the credit line. It is not
advisable to pay the obligation before the stipulated date.

Ways to Conduct Cash Disbursements

1. Playing the Float. It is the process of taking advantage of the clearing system in order
to make the use of the funds in the company’s bank account. It means that the
outstanding checks of a company not presented to the bank are more than the amount
covered by the bank balance.

2. Payment by Draft. A draft is issued by the debtor or the issuer to the creditor and the
creditor presents the draft to the issuer’s bank for collection. Bank drafts are typically
available for spending in the recipient’s account within one business day, and it’s unlikely
that the bank can reverse the deposit a few days or weeks later. The advantage of the
draft is that it delays the disbursement of funds to the creditor.

3. Auto-Debit Transfer. This bank service provides a company with two or more
accounts to facilitate payments and collections. One account is a savings account, while
the other is a current account that is demand or checking account. The current account is
maintained with a zero balance. All payments will be made by a company through
checks, and all deposits or collections will be made on the savings account.

4. Debit Transfer. This one is the manual way of doing the auto-debit transfer. It manually
prepares another check so it can be transfer to the current account and is determined by
the total charges made to the company. It transfers just enough funds to cover the
checks presented for payments.

5. Stretching of payables. It is a process of extending payments to suppliers or

creditors. The payments should only be delayed for a time that is tolerable to the
creditor.
6. Centralization of disbursements. This way, companies are able to monitor their
monitor their payments and satisfy their obligations to optimum time. It can select
creditors who must be paid first and extend payments to those who can tolerate delays.

7. Use of statistics to predict the amount of checks issued. By looking at the

historical disbursements of a company, one can establish how much funds must be
deposited to cover the checks issued. This is frequently done for payroll and dividends
payments. (kindly review the example in our book, page 194)

Analysis: The total incremental income from salary date to 5 days from the salary date is
P4,375 and the total incremental income from 5 days to the 10th day from salary date is
P1,312.50. We are going to add the total to get the total incremental value. And it equals
to P5,687.50.
By getting the total incremental income from the salary date up to no. of days is (payroll
amount × percent of checks issued × interest rate × no. of days needed over 360)