Ch.

16: Liquid Asset

Management
Liquid Asset Management

CASH- motives for holding cash:

 Transactions: to meet cash needs
that arise from doing business.
 Precautionary: having cash on hand
for unexpected needs.
 Speculative: to take advantage of
potential profit-making situations.
Cash Management

Objectives:
 have enough cash on hand to meet
disbursal needs.
 Minimize investment in idle cash
balances.
 Tradeoff: cash decreases risk of
insolvency, but earns no returns
 Cash Management
Managing Cash Inflow
 Reducing Float can speed up cash receipts.
 Mail Float: length of time from the
moment a customer mails a check until the
firm begins to process it.
 Processing Float: the time required by a
firm to process a check before it can be
deposited in a bank.
 Cash Management
Managing Cash Inflow
 Reducing Float can speed up cash receipts.
 Transit float: time required for a check to
clear through the banking system and
become usable funds.
 Disbursing float: occurs because funds are
available in a firm’s bank account until its
payment check has cleared through the
banking system.
 Cash Management
Managing Cash Inflow
 Lockbox System
Instead of mailing checks to the firm,
customers mail checks to a nearby P.O.
Box.
A commercial bank collects and deposits
the checks.
This reduces mail float, processing float
and transit float.
 Cash Management
Lockbox System benefits:
 Increased working cash - reduces time
required to convert receivables to cash.
 Elimination of clerical functions - bank
handles receiving, endorsing, totaling and
depositing.
 Early knowledge of dishonored checks -
firm learns of customers’ bad checks
faster.
 Cash Management
Managing Cash Inflow
 Preauthorized Checks (PACs)
Arrangement that allows firms to create
checks to collect payments directly from
customer accounts.

This reduces mail float and processing

float.
 Cash Management
PAC System benefits:
 Highly predictable cash flows.
 Reduced expenses - eliminates billing
and postage costs; reduces clerical
processing costs.
 Customer preference - eliminates
regular billing for customers.
 Increased working cash - dramatically
reduces mail float and processing float.
 Cash Management
Managing Cash Inflow
 Depository Transfer Checks
(DTCs)
 Moves cash from local banks to
concentration bank accounts.
 Firms avoid having idle cash in
multiple banks in different regions of
the country.
 Cash Management

DTC System benefits:

 Lower levels of excess cash -
 Reduced expenses - eliminates billing
and postage costs; reduces clerical
processing costs.
 Customer preference - eliminates
regular billing for customers.
 Increased working cash - dramatically
reduces mail float and processing float.
 Cash Management
Managing Cash Inflow
 Wire Transfers
Moves cash quickly between banks.
Eliminates transit float.
 Cash Management
Managing Cash Outflow
 Zero Balance Accounts (ZBAs)
Different divisions of a firm may write checks
from their own ZBA.
Division accounts then have negative balances.
Cash is transferred daily from the firm’s
master account to restore the zero balance.
Allows more control over cash outflows.
 Cash Management
Managing Cash Outflow
 Payable-Through Drafts (PTDs)
Allows the firm to examine checks written
by the firm’s regional units.
Checks are passed on to the firm, which
can stop payment if necessary.
 Cash Management
Managing Cash Outflow
 Remote Disbursing
Firm writes checks on a bank in a distant
town.
This extends disbursing float.
(Discouraged by the Federal Reserve
System)
 Marketable Securities
Considerations
 Financial Risk - uncertainty of
expected returns due to changes in
issuer’s ability to pay.
 Interest rate risk - uncertainty of
expected returns due to changes in
interest rates.
 Marketable Securities
Considerations
 Liquidity - ability to transform
securities into cash.
 Taxability - Taxability of interest
income and capital gains.
 Yield - Influenced by the previous 4
considerations.
 Marketable Securities
Types
 Treasury Bills - short term securities
issued by the U.S. government.
 Marketable Securities
Types
 Federal Agency Securities - Debt
issued by agencies, including:
 Federal National Mortgage Association
(Fannie Mae)
 Federal Home Loan Banks
 Federal Land Banks
 Federal Intermediate Credit Banks
 Banks for the Cooperatives
 Marketable Securities
Types
 Bankers’ Acceptances - short term
securities used in international
trade. Sold on discount basis.
 Negotiable CDs - short-term
securities issued by banks, with
typical deposits of $100,000,
$500,000 and $1 million.
 Marketable Securities
Types
 Commercial Paper - short-term
unsecured “IOUs” sold by large
reputable firms to raise cash.
 Repurchase Agreements - an investor
acquires short-term securities subject
to a commitment from a bank to
repurchase the securities on a specific
date.
 Marketable Securities
Types
 Money Market Mutual Funds - a
pool of money market securities,
divided into shares,
which are sold to
investors.
Accounts Receivable Management

Size of Investment in Accounts

Receivable
 Percent of Credit Sales to Total Sales
 Level of Sales
 Terms of Sale
 Quality of Customer
 Collection Efforts
Accounts Receivable Management

Terms of Sale
 quoted as a/b net c , which means
“deduct a% if paid within b days,
otherwise pay within c days.”
 example: 3/30 net 60, means “deduct
3% if paid within 30 days, otherwise
pay the entire amount within 60 days.”
Accounts Receivable
Management: opportunity cost

a 360
x
1-a c - b
opportunity cost of forgoing 3/30 net 60:

.03 360
1 - .03
x 60 - 30

= 37.11%
Inventory Management
 Too much inventory is expensive and
wasteful.
 Not enough inventory can result in
lost sales.
Inventory Management
 Raw materials inventory - basic materials to be
used in the firm’s operations.
 Work-in-process inventory - partially finished
goods requiring additional work before
becoming finished goods.
 Finished-goods inventory - completed products
that are not yet sold.
 Stock of cash - inventory of cash to allow
payment of bills.
Inventory Management
 Optimal inventory order size: the
Economic Order Quantity (EOQ)
model:
 Estimate of the cost minimizing
amount of inventory to order
 Order point
 Average inventory
 Economic Order
Quantity Model

Q* = 2SO
C
Q* = opt. inventory order size in units
C = cost of carrying 1 unit in inventory
S = total demand in units over planning
period
O = ordering cost per order
 Example: Inventory Management

Q* = 2SO
C
Q* = inventory order size in units (Q*= 2000)
C = cost of carrying 1 unit in inventory = 1.25
S = total demand in units over planning
period = 10,000 units
O = ordering cost per order = $250