Modern Working Capital Management

Chapter 2
Presentation by Khaleda Khatun
Cash Inflow & Outflow
Managing Cash In Flows & Out Flows :
• In business there are couple of old phrase:
• 1. Cash is king
• 2. happiness is a positive cashflow.
• Survey shows that 60% of the business failed due to cashflow problems.
• Making profit is nice but cashflow is necessary.
• Cash management is the key to business success. Why?
• Start up a business needs cash.
• Existing business can sustain if they can generate cash.
• Cash is the single most important element of survival for a small business. It gives them
security in unstable times.
• It also gives them opportunity to take advantage of strategic investments or take
advantage of opportunities to reduce costs.
 Cash Management Cycle

Business operation: cash collection – cash payment= Deficit or

Surplus.
• If surplus company goes for investment. If deficit goes for borrowing
or disinvestment.
• Therefore, firm tries to accelerate cash collection and also tries to
defer cash payment.
• Cash Planning/ cash budget: Identifies sources of cash and uses of
cash.
Managing Cash In Flows & Out Flows :
• The term cash management refers to all those activities relating to planning and
execution of decisions involving cash (and near cash items) as it enters the firm’s
control horizon till it remains there – that is, collecting, holding and disbursing
activities of cash and near cash items.
• Cash management activities include – planning and execution of plans for:
• (1) Collecting cash from different sources;
• (2) Disbursing cash in different uses; and
• (3) Holding or investing cash while within the firm.
• Successful cash management involves not only avoiding insolvency but also reducing the
length of A/R, increasing collection rates, deferring payment, selecting appropriate short term
investment opportunities and increasing cash on hand to improve a company's cash position and
profitability.
Needs for holding Cash & Marketable Securities:
• Cash (& also marketable securities) is the least productive asset of any firm. They are not
the part of any assets relating to production or selling process like the inventories or A/C
receivable; nor are they required for production of goods & services like the fixed assets.
• Even if the cash is temporary invested in M/S, its return is much less than the return on
other assets held by the firm.
• However, every firm needs cash (or cash deposits in non-interest-bearing checking A/c or
currents A/C) in order to perform the following activities of the firm:
• Daily Transaction Needs/ To maintain operating activities of the business: One of the
very important reasons for holding cash (or current A/c deposit) is to meet the daily
transaction demand of the firm. Every firm makes payment for wide varieties of activities
like – payments against accrued wages, A/c payables, utilities bills etc. For these purposes,
firms must maintain sufficient cash balance.
• Cash and Near-Cash for Hedging:
• These provisions can be maintained in the form of cash; but often they are maintained in
the form of highly liquid marketable securities of very short nature or what we can
call them as near cash or quasi money items.
• Some firms do also maintain arrangements with their bankers; whereby they can get
the desired payment capacity either in the form of O/D (overdraft/over drawing- an
arrangement with bank or lending institution where account holder can withdraw money
even when the account has no funds in it or has insufficient funds to cover the amount of
the withdrawal) or CC (cash credit).
• But in deciding over the issue as to what shall be the form of this hedging, the firms
do consider the cost aspects.
• The first issues as you were told in the Chapter – 1 is the cost of hedging and un-
hedging.
• The secondary issue appears when hedging volume is considered. If the total money is
held for hedging in the form of cash, there is no explicit cost involved. But cash earns
nothing, so it has some implicit or opportunity cost. On the other hand, if safety stock of
Transaction Costs
This transaction costs depends on the:
(i) Nature of security
(ii) Condition of money market, and
(iii)On the urgency with which the marketable security is converted into cash.

• The bank loan has explicit costs. Even if no money is withdrawn, the banker must
be paid with some commitment fee. The decision as to the types of provision(s) to
be used for hedging therefore depends on the transaction pattern of the firm.
Short term Surplus and Temporary Investment:
• Business firms involved in seasonal pattern do have demands of resources of similar seasonal pattern
too. Consequently, these firms possess excess liquidity during off season while cash crunch during peak
seasons. These off-season cash surpluses are needed by the firm during the following peak season of
their business. The surplus cash during off-season can be used :
• Either for repayments of the long-term loans of the firm (if any) and can again be raised before the
start of the next peak season.
• Alternatively, these can be deployed in some temporary investment opportunities, especially in the
marketable securities.
• The first option is costly as retirement of old debt and or issuing new debt investments are costly
activities.
• Rather proper planning and investment selection strategy can yield a reasonably good return.
• All those issues lead us to the following conclusions:
• Holding reasonable amount of cash or near cash items is essential for any firm even though the yield
from such holding may be significantly lower than the average yield of firm’s all other assets of the firm.
Some Special issues on investing surplus cash in M/S:
• As it is already clear that, the Finance Manager of a firm is required to maintain cash balance or near cash items
for hedging purpose, there must also be some issues that need special attention of the Finance Manager. These
issues are:
• Liquidity
• Safety, and
• Profitability.
• Liquidity: The term liquidity here means the potentialities of the marketable securities to be converted in cash
(or sold in the market) immediately without eroding significant value of the investment. The treasury bills and
high graded commercial papers (not available in Bangladesh) often fulfill the liquidity requirements of a firm.
Stocks of ‘Blue chips’ companies, government bonds and Certificates of Deposits (CDs) of top order banks do
also meet liquidity criteria pretty confidently.
• Safety: The safety of funds invested by a company is best provided by the government securities (T bills).
Because these are default free instruments, so there is no safety concern for the firm. Although some experts
opine that, governments of some developing or least developed countries specially those with high ‘deficit
finance’ and other internal troubles can default at times. Any how, securities other than those of the
government, like stocks and commercial papers of ‘blue chips’ companies are considered as default free
securities for the short run.
Some Special issues on holding cash balance (Contd)
• Profitability: In addition to safety and liquidity, profitability from the investment is also a
matter of concern for the Finance Manager. Therefore, profitability or return or yield from
the marketable security over the costs of investment and liquidation (disinvestment) must
be considered before making any short- term investment decision.
• The return in general depends on nature of security and yield curve. Therefore, the term
structure of interest must be considered carefully. You probably know that the term structure
of interest rate explain the relationship between terms to maturity and the interest yield of
a particular risk class security. Thus, it is empirically observed that, as the term to maturity
increases, the yield also do increase but at a declining rate as you can see it from the graphical
presentation. This yields or returns are influenced by various factors like
• Inflation rate
• Investors’ expectations about forward rates
• Investors perception about interest rate risk
• Relative demand and supply for securities of different maturities.
Relationship between terms to maturity and the interest yield
of a particular risk class security
Theories of Terms Structure of Interest Rate
• There are different theories that explain the shape of Yield curve which is in
general upward slopping as shown in the previous graph. However, there are
situations when the curve can be downward slopping or humped or flat. These
theories namely
• Pure Expectation Theory
• Liquidity Premium Theory
• Preferred Habitat Theory, and
• Market Segmentation Theory
• These theories explain why the yield curves can assume different shapes like
upward downward humped or even flatly slopping. (This course will not
explain these theories in detail but in Financial Market course you will/ learn or
already have learnt these.)
Theories Terms Structure of Interest Rate
• The Pure expectation theory: The expectation theory holds that; investors investment
decision is influenced by their expectations about the inflation rate and the resultant interest
rate. Thus, when they expect the inflation rate -vis-a-vis the interest rate will go up in future
they will start demanding longer term funds more than shorter maturity funds. This higher
demand for longer maturity funds will enhance the market interest rate. The opposite situation
do appear when they expect the inflation rate will fall, i.e. the market interest will go down. This
expectation about lower future interest rate for lowers the relative demand for larger maturity
funds and thus lower the interest rates.

The Liquidity Premium theory of Keynes explains only the normal upward
slopping yield curve. According to this theory, the people in general like to hold liquidity.
They will agree to abstain from holding liquidity only they are duly compensated for such
parting with their liquidity. Thus, the longer the time (term) that one individual remains
parted with the liquidity, the greater shall be the premium. So, the theory suggests that the
Yield Curve is upward slopping.
Theories Terms Structure of Interest Rate
• The Preferred Habitat theory (investors preference or need): suggests that, every supplier of
funds as well as the users of funds has a preferred choice of market for borrowing or lending of their
funds. One would switch from the preferred market only when there are sufficient incentives to
change the preferred habitat and to move to a new arena. Thus, when there is a situation where
significant numbers of participants are switching from their preferred habitat there will be swings in
the yield curve – from upward to flat or to a downward slope.

• The Market Segmentation theory (based on market structure):The market segmentation theory
holds that; investors have preferences for different maturities of securities – that is market is
segmented by securities of different maturities, short- term and long- term financial market where the
suppliers and users of funds act independently and determine the interest rate according to demand
and supply situation in the market. Therefore, when for any reason, there is disequilibrium (excess
demand or supply or shortage of fund) in any segment of market, funds suppliers or investors will
move to other segment causing upward interest where funds will be scarce in comparison to demand
for the same. Thus, upward or downward slope of yield curve is the outcome of relative demand for
and supply of funds in relevant segments of market. This theory also suggests that, if demand for term
loan is higher than that of short term and long -term market, the Yield curve shall be humped.
Risk of Marketable Securities
• In addition to term structure of interest rates, the marketable securities suffer from the issue of
default risk.
• The default risk refers to the situation where the issuing firms of the securities come to a
defaulting situation by failing to honor its commitments/obligations regarding:
• interest payments and or
• or repaying the principal sum borrowed.
• The securities in which investment can be made are classified in a continuum(range) at one end :
• securities considered as absolutely default free (T bills of government and other government bonds)
• to another end defaulting securities (Junk bonds or bonds of the firms under the receivership for bankrupt
declaration).
• The yield of the securities differs based on their default potentials. The yield of least default risk
securities are in general the lowest one on the other hand high defaulting securities do offer higher
yield.
• The cash managers are in general inclined to invest their surplus of hedging funds in least
default risk securities in order to gain highest safety and liquidity .
Different types of securities where a firm can use their surplus funds in
the Money Market
(1) Treasury bill.
(2) Commercial paper
(3) Certificate of deposit.
(4)Banker's acceptance
(5) Repurchase agreement (REPO)
(6) Euro $
(7) ‘Hedged dividend capture strategies’ etc.

• Marketable: claims are negotiable or saleable in the marketplace

• Short-term, liquid, relatively low-risk debt instruments
• Issued by governments and private firms
Different securities where firm can use their surplus funds
(1) Treasury bill.
• Simplest form of borrowing wherein the government raises money by selling
bills to the public
• Initial maturities are 4,13,26,or 52 weeks. Minimum denominations $100,
highly liquid, low transaction cost and with not much price risk. Earnings on T-
bills exempt from taxes.

• This investments are generally considered to be almost free of default risk.

• Since these are short term securities the rate of return is minimum.
Disadvantages of T Bills
• T bills earn a lower return than do other instruments will a bit more default risk. To earn extra return,
many firms are willing to invest in slightly higher risk instruments, such as commercial paper.

• Commercial paper:
• (i) C. P. is larger denomination( start at $100000) unsecured debt –
• (ii) generally, maturity less than 30 days to 270 days
• (iii) Issued by firm, finance Co's & bank holding Co's.
• Since there is some default risk involved, the yield of C. P. little bit higher
than the T bill of the same maturity.
• But most CPs are backed by bankers' line of credit of equal denomination,
so that, when the maturity date arises, if the CP issuing firm fails to repay
the loan, it can draw the money from the bank and honor their
commitment. Thus, these CPs become almost default risk free.
 Certificate of deposit & Other Securities
• Certificate of deposit: These are types of bank deposit where the investors can deposit
a specific amount for specific period & get a certificate of deposit often bearer or negotiable
in nature having a denomination that contains the principal sum deposited plus interest rate.
The bearer C/DS are marketable securities having high grade liquidity. The investors gain
from the spread or difference between the selling & purchase price of the C/Ds, C/Ds are
subject to the (i) banker’s default as well as (ii) interest rate risk.
• Banker’s acceptances: Banker’s Acceptance is a Bill of Exchange accepted by a bank on
behalf of a client (who is a buyer on credit or otherwise obligor to a debt) which is created by
the seller of that client.
• It is an unconditional order to a bank by a customer to pay a sum of money at a future date to
a designated person
• Typical maturities range from 30 to 180 days.
• Such bills become very good marketable securities. Even the central bank accepts these bills
when a commercial bank approaches CB as the lender of last resort.
Different securities where firm can use their
surplus funds
• Repurchase agreement or RIPO: are very short-term investment or
financing arrangement. Where deficit firm sale of their holdings of
marketable securities (often T bills) to a surplus firm with the
condition that the seller will buy back those securities at or on a future
date at a higher price. Thus, those securities in fact are used as security
collateral.
• Euro $ : These $ denominated loans or C/DS held by non-US citizens
or bankers or firms. These are commonly of 1 week to 6 months of
maturities having modest default risk & marginally higher interest
than the domestic deposit.
Hedged Dividend Capture Strategies :

• In countries where tax system given the opportunity to differential treatments on

dividend earnings, interest earnings and capital gains these hedged dividend strategy
offers return higher than T bills, C. Papers etc.
• Thus, if a firm wants to capture the dividend income of a stock but wants to avoid the
capital gain (loss) of the stock can buy the stock along with an option on the same. This
call option will keep the firm's investment intact (no capital loss). Another strategy can
be the buying stocks of an index funds and hedging it will a call option on index funds.
• This will safeguard the firm from on adverse price fluctuation and at the same time
enable them to earn dividends.
• Thus, all these opportunities mentioned above offers a firm to use their surplus funds in
the money market. The opportunities depend on condition of money markets, its depth
breadth. If the money market is not broad enough, then the firm must hold their surplus
cash in bank account only an it happens in Bangladesh.
Lock Box System and Cash Flows Management
• We have so far talked about need for & mechanisms of investing excess cash balance. .
Now we would like to talk about another aspect of managing cash flows.
• The cash balance we talked about is the cash within the firm’s control. Now we will move
to the cash in transit i.e., the cash or check being mailed or placed in the process of
transmission.
• That means, the customers of the firm has put the check or cash in the process of
transferring to the credit selling firm. In this regard you must bring it to your mind that
when a customer sends or mails its check the responsibility of the credit department is
completed & it is the responsibility of the cash management department or cash manager
to expedite the cheque clearing process.
• Moreover, in this chapter we will assume that most of the payments are made through
cheque. Although in Bangladesh cash transaction is frequent, especially among the small
firms, but most of the larger firm uses cheques as a medium of exchange. Therefore, the
importance of accelerated cheque clearing process will be the major content of this
section.
Need for Accelerated Cash Clearing
• Before initiating the discussion on accelerated cash clearing process, I would like to explain why such
acceleration is required.
• Assume that ABC firm receives on average Tk. 5 lakh worth of cheque per day from its customers.
• On average it takes 4 days to receive a cheque from the customers after those being mailed by them.
• Again, half or 0.5 days are required by the credit selling firm to make necessary book entries & to deposit the
cheques to the bank & finally another 3 days on average required to get the cheques cleared by the banks.
• Therefore, it takes on average 7.5 days for the credit selling firm to get the payments made by the customers
in the form of cash in its business.
• Thus, on an average (7.5days x Tk. 5 lakh) = Tk. 37.5 lakh or Tk. 3.75 million remain unutilized for the firm
all over the times.
• If the cost of capital of the firm is 10% then the shareholders wealth is not gaining the benefit of (3.75*0.1) =
Tk.375 million or Tk.375000.
• If the customers’ cheque collection process can be expedited so that the cash in transit is held for shorter
period, then the shareholders would have gained the benefit of greater volume of wealth.
• Therefore, the Finance Manager will, in order to maximize wealth, try to accelerate the process of cheque
collection or minimize the transit period.
 Opportunity Cost of Float

Three Types o Float:

1. Mail Float 2. Office Float 3. Bank or Clearing Float
Calculation of cost of float
• A company has five remittances for the typical month as listed below. Assume typical month is 30 days. The
days in mail float and clearing float for each remittance are also shown. Processing float is negligible.
Assume that the remittances and collection float are stable throughout the remaining eleven months.
• Remittances(Tk.) Mail float(days) Clearing float (days)
• 100,000 2 1
• 5000 7 2
• 300,000 1 1
• 10000 5 1
• 150000 4 2
• Requirements: i) Calculate the total dollar- day float for the month
• ii) Calculate the average dollar day float
• iii) Average collection float
• iv) If the annule opportunity cost is 4%, calculate the annual cost of float.
Calculation of cost of float
• Total Dollar day float= Remittances( Tk.)* collection float
• 100000*3= 300000
• 5000*9= 45000
• 300000*2= 600000
• 10000*6=60000
• 150000*6=900000
• Total Dollar day float= Tk. 1905000
• Total remittance during the month= tk.565,000
• Requirement i) Total dollar- day float for the month= tk. 1905000
• Ii) Average dollar- day float= $ day float/Days in month=1905000/30= tk. 63500
• Iii) Average collection float= $ day float/ total remittances= 1905000/565000 =3.37 days
• iv) annual cost of float= Average dollar- day float* opportunity cost =63500*.04= tk. 2540
Accelerated cheque collection or minimization of cash in
transit:
• The money in the transit or in float can be accelerated in 3 different
stages namely –
• Mailing process minimization.
• Office timing or office floats minimization. &
• Bank timing or clearing float minimization
Mailing process minimization
• The mailing process can be minimized if the credit selling department
can ensure that checks are mailed using quick mailing systems like
E.M.S. or other courier services, and then the mailing float can be
significantly minimized.
• Another action can be the use of ‘lock box’ system where credit
selling firm opens mailboxes in different areas and arranges cheque
collections in those areas where most of the customers are located.

• The keys to these mailboxes are given to the bankers with authority so
that they can collect the cheques and directly deposit those in the bank
account opened in that areas’ bank.
Mailing process minimization

For this purpose, two additional steps are required by the firm to
be taken:
• To advise the customers to mail the checks to the designated P.O.
box # and not to the credit selling firm and
• To open accounts in that locality bank having the arrangement that the
banker will open the P.O. box ,collect & clear the cheques coming to
the post boxes, and remit the same to designated central bank account
of credit selling firm.
• The above steps, if taken carefully and systematically, will minimize a
firm’s mail float and eliminate the office float.
Eliminating the Office Float

• On the other hand, such arrangements will enhance the firm’s bank
float because:
• Bank will need some time to get the cheques cleared and
• some more time to transfer the same to the customer designated
central account.
• However, as banks will be responsible for local area cheque collection,
the overall bank-clearing float will be minimized.
• Moreover, if electronic money transfer system is used the bankers can
further minimize the time.
Accelerated Cheque Clearing System:
• A credit-selling firm will have very little control over the bank in accelerating check-
clearing process.
• Nevertheless, the firm can accelerate the process through selecting the banks, which are
capable of accelerated check clearing process. As you can see in your textbook that, in
the USA, some banks depend on Federal Reserve Banks (Central Banks) to get the checks
cleared while some banks can do it through their own clearing mechanism.
• Thus, some banks have advantage in getting their checks cleared in a shorter span of time.
• However, in a country like ours where Bangladesh bank is the only clearing house
manager, things are not that easier.
• In cases of inter district cheques clearing, overall days/weeks required before it can finally
be settled from one district to other is pretty-long. Nevertheless, most banks in the private
sectors having wider and electronic branch network can facilitate quicker and efficient
fund transfer.
• Thus, in countries like Bangladesh the acceleration cheque collection or minimization of
bank float depends on the choice of bank and on the location of the customers.
A Special Issue – Lock Box System:
• Although lock box system is not operative in Bangladesh, but it can be
expected that very soon with the advent of modern banking system,
most banks in Bangladesh will start offering lock box system. I
therefore would like to talk about lock box system with some greater
details.
Most important issues relating lock box
• The most important issues relating lock box operational strategy should be to
determine:
• The number of lock boxes to be established
• The locations where the lock boxes should be established
• Identification of lock boxes to which any particular customer should be advised to send the
checks.
• These issues are further discussed below:
• The location problem depends largely upon the cost and benefit analysis. The cost of
lock boxes are fixed cost of P.O. boxes and the cost of additional bank services for
• collection
• clearing and
• Remitting the funds collected by the banks.
• The benefit is the minimization of average floatation period and thus minimization of
stuck-up cash balance or minimization the opportunity cost of float.
The cost involved in lock box operation
• include – (a) Fixed cost of Lock box renting (b) The variable cost of check
collection and check clearing (c) Sending the accumulated funds to the
destination or designated bank of the firm.
• Collecting all these data the computer program for Lock box location can be
determined.
• Some problems about Lock box location decisions:- The lock box location
determined by the computer programs uses the data input prepared by the firms
assumed certain data base, like
• (1) Customer's location or zone,
• (2) Banks cost data,
• (3) Representative Volume of cheque
• But these informational assumptions suffer from certain limitations which affect
the optimum output of the lock box system i.e., minimization of floatation cost.
Calculation of cash collection cost

• Formula to calculate cash collection:

• TC= N[F*D*(i/360) +VC] +FC
• N= # of remittance processed
• F= the average face value of remittance
• D= # of days it takes to clear the check
• i= annual opportunity cost
• VC= vc charged for each remittance item
• FC= fc of managing the collection system
Limitation of These Assumptions
• The following are the main limitation of those assumptions:
• Determining customers’ zones as opportunity cost of float is computed as the sum
of all mail & clearing float cost, the customer zones are required to be defined
with homogeneity of their locations. Other wise optimum strategy for L.B. cannot
be defined.
• But in situations where a customer mails his/her cheques from Dhaka but his bank
is located in Chittagong or Khulna if such customers are placed in Dhaka zone’s
Lock box; mail float will be minimum but clearing float will be longer and hence
this customer should be zoned on the basis of relative length of mail float &
clearing float.
• Bank cost data: Sometimes banks offer different types of L.B charges. If the
service is L.B. only than service charges are relatively higher, while if the firm
receives a package of clear services including lock box borrowing etc, the true
cost of lock box become difficult to ascertain.
Factors
• Obtaining representative sample of cheque volume & origination:
Usually firms sample one-month check movement data to ascertain. The
frequency & volume of checks flowing from different destination. But
if the firm has
• (1) seasonal cliental pattern or
• (2) if for any reason clients of one regional behaves abnormally in any sample
period. The overall zoning pattern will be misleading.
• Cost of float: The L.B. location analysis system uses the opportunity
cost of float as the product of total floats in $ & the firm’s cost of
capital. It intends to account for time value of money or the NPV of the
cash flow stream in perpetuity. Thus it ignores the growth potential of
future cash flow.
Lock-box Location & Disbursing Firms:

• Through L.B location the receiving firm attempt to minimize float time.
But the disbursing firm, on the other hand will attempts to maximize or
stretch the clearing time. Consequently, they will adopt such disbursement
strategy which will negate the L.B. strategy of the receiving firms.
• Although these limiting factor affect the optimum result yet a careful
consideration of all those issues mention above can minimize the total float
& there by make the L.B. strategy a success.
• Cash Concentration Strategy: Once the L.B. locations are determined
the next step is to make those cash flows coming to the lock box bank.
Finally, be collected in to a central or main bank A/C of the firm. The
process of collection of funds from the L.B. bank to the central bank of
the firm is known as cash concentration.
Advantages of The Cash Concentration Strategy
• The cash concentration strategy has 2 strategic advantages –
• If funds are required to be invested the transaction cost will be the minimum
with pooled funds than with scattered smaller volume of funds.
• The return potential will be higher if the volume of fund is big enough rather
than smaller scattered funds.
• In concentrating cash, firms channel collected funds from the depository
banks to the central concentration bank, sometimes through regional
concentration banks
• the regional concentration bank will ultimately send those funds to the main
concentration bank. A typical cash concentration system look likes the
following figure.
 Cash Concentration
• A typical cash concentration system look likes the following figure.
Concentration Banks
• The choice of central concentration bank and regional concentration
banks depends on
• (1) Availability of clearing facilities in the regions,
• (2) Nature and diversity of cheques sent to a lock box system
• Any how the final decision on the number of regional concentration
banks depends again on time and cost of remittance from the
depository banks to the main concentration bank.
Disbursement Management:
• The lock box system as we have studied above aimed at reducing the cash collection
float so that cash remain unused for the minimum time or that the checks get cleared
from the customers A/C as soon as possible.
• On the other hand, the customers will attempt to maximize the disbursement time so
that the checks get cleared from the bank account as late as is possible. The actions
to these direction is known as disbursement management.
• The aim of disbursement management is to retain cashflow if is possible so that firm
will have maximum amount of funds available for investment and transactional
purposes. There are set of techniques for disbursement management.
• These include
• (1) Management of disbursement float,
• (2) Zero Balance A/C and
• (3) Controlled disbursement.
Disbursement Management:
• Management of disbursement float: This is anti lock box strategy. Under this strategy the
disbursing firms attempt to maximize mail and clearing floats. The mailing floats can be maximized by
deliberate mistakes in sending checks to receiving firms office rather than to lock box address. Thus,
mail float and office float is changed. The disbursing firm can also send checks of the banks which are
in place far away from lock box bank. Thus, the clearing float can be enhanced.
• Zero balance A/C: Under this strategy, the disbursing firm arrange its disbursement in such a way that
its disbursed checks presented by the receiving firm’s bank (collecting bank) to the disbursing bank
(paying bank) at a time when there is some funds concentrated in the accounts of the disbursing firms.
• It is a synchronization strategy whereby the disbursing firm’s A/C balance remains zero or near zero.
• This strategy will minimize the cost of unused or idle funds of the disbursing firm. This strategy is
possible only when the disbursing firm has an ‘overdraft’ or ‘cash credit limit’ provision with its
banks that no check is dishonored when presented for clearance if there is insufficient or zero balance
at that time.
• Another strategy can maintain cash balance in one account where from cash can be transferred
through electronic transfer when ever cash is found short at the disbursing bank. This strategy attempts
to synchronize cash inflow and outflow in the disbursing bank so that extra cash balance is not held in
the bank account idle.
Disbursement Management:
• Controlled disbursement: This strategy is possible when a firm has very high
frequency of transactions involving bank so that continuously cheques are
presented to the disbursing bank. In this strategy the disbursing firm keeps fund in
the disbursing bank a/c only enough to clear checks presented in the following
working day along with a safely stock of cash balance is also maintained with the
disbursing bank A/C so that any uncertainty can be met.
• Infect ‘Disbursement Management Technique’ attempts to minimize the volume
of idle cash held by a firm either in float or in bank account.
In Class Practice Problem
• Calculate the total cost for a cash collection system under ‘Lock Box’ system and
‘Centralized ‘system using the following information. Which system is most effective for
the firm? Information Common data Lock box system Centralized system
Number of remittances 1000
processed (N)

The average face value of $1500

remittances (F)

Number of days it takes to 7 6

clear the check (D)

Annual opportunity cost 10%

( i)

Variable cost charged for .25 .20

each remittance item (VC)

Fixed cost of managing the $100 $600

collection system(FC)