Ch. 16: Liquid Asset Management

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Ch. 16 Liquid Asset Management
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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.

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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

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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.

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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 firms bank account until its
  payment check has cleared through the banking
  system.

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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.

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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.

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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.

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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.

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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.

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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.

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Cash Management

• Managing Cash Inflow
• Wire Transfers
• Moves cash quickly between banks.
• Eliminates transit float.

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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 firms master
  account to restore the zero balance.
• Allows more control over cash outflows.

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Cash Management

• Managing Cash Outflow
• Payable-Through Drafts (PTDs)
• Allows the firm to examine checks written by the
  firms regional units.
• Checks are passed on to the firm, which can stop
  payment if necessary.

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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)

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Marketable Securities

• Considerations
• Financial Risk - uncertainty of expected returns
  due to changes in issuers ability to pay.
• Interest rate risk - uncertainty of expected
  returns due to changes in interest rates.

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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.

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Marketable Securities

• Types
• Treasury Bills - short term securities issued by
  the U.S. government.

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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

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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.

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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.

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Marketable Securities

• Types
• Money Market Mutual Funds - a pool of money
  market securities, divided into shares,
  which are sold to
  investors.

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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

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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.

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Accounts Receivable Management opportunity cost

• a 360
• 1 - a c - b
• opportunity cost of forgoing 3/30 net 60
• .03
  360
• 1 - .03 60 -
  30
• 37.11

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Inventory Management

• Too much inventory is expensive and wasteful.
• Not enough inventory can result in lost sales.

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Inventory Management

• Raw materials inventory - basic materials to be
  used in the firms 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.

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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

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Economic Order Quantity Model

• 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

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Example Inventory Management

• 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