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S.K. Tiwari
E X E C U T I V E   S U M M A R Y
The cash balance shown in the company's Ledger may not be the same as the available balance in its bank account. The difference is the net float. When the firm has written large number of cheques awaiting clearance, the available balance will be larger than the ledger balance. When the firm has just deposited large number of Cheques, which have not been collected by the bank, the available balance will be smaller. If the firm can predict long it will take the Cheque to clear, it may be able to play the float and get by a smaller cash balance. Firms can also manage floats by speeding up collections and slowing down payments. Some of the ways to spped up the collections are concentration banking and lockbox banking. With the advent of technological boom companies worldover are moving towards ECS (Electronic Clearance Scheme), to reduce the floats.

Cash management has changed significantly over the past 2 decades for two reasons. First, from the early 1970s to the late 1980s, there was an upward trend in interest rate that increased the opportunity cost of holding cash. This encouraged financial manager to search for more efficient ways of managing cash. Second, technological developments, particularly computrised electronic funds transfer mechanism changed the way cash is managed.

Most cash management activities are performed jointly by the firm and its banks. Effective cah management encompasses proper management of cah inflow, and outflows, which entails (1) improving forecasts of cash flows, (2) synchronizing cash inflows and outflows, (3) usinig floats, (4) accelearing collections, (5) getting available funds to where they are needed, and (6) controlling disbursement. Most businesses are conducted by large firms, many sources and make payments from a number of different cities or even countries. For example, companies such as IBM, General Motros, and Hewlett-Packard have manufacturing plants all around the world, even more sales offices, but most of the payments are made from the cities where manufacturing occurs, or else from the headoffice. Thus a major corporation mightnhave hundreads of bank accounts, and since there is no reason to think that inflows and outflows will balance in each account, a system must be in place to transfer funds from where they come into where they are needed, to arrange loans to cover net corporate shortfalls, and to invest net corporate surpluses without delay.

We will discuss how floats can be effectively managed to accomplish these tasks.
The efficiency of the firm's cash management programme can be enhanced by the knowledge and use of various procedures aimed at
  1. accelerating cash inflows, and
  2. controlling cash outflows
With reference to the control of inflows and outflows, float is an important technique to reduce the length of the cash cycle. When a firm receives or makes payments in the form of Cheque etc., there is usually a time gap between the time the Cheque is written and when it is cleared. This time gap is known as float. The float for the paying firm referes to te ime that elapses between the point when it issues a Cheque and the time at which the funds underlying the Cheque are actually debited in the bank account. For the payee Firm, float refers to the time between the receipt of the Cheque and the availability of the funds in its account. So, float denotes the funds that have been dispatched by a payer (the firm making the payment) but are not in a form that payee (the firm receiving the payment) can spend. The float also exists when a payee has received funds in a spendable form but these funds have not been withdrawn from the account of the payer.

To get an idea of the float mechanism and its utility in the management of cash inflows and outflows, one must know the related banking procedure. When a Cheque is issued by the paying firm, the bank balance of the firm is not imeediately reduced, rather the bank reduces the balance only when the Cheque is presented to it either personally or through the clearing system.

Similarly, when the firm receives a Cheque from the customer and deposits the Cheque in the firm's account, the amount, rather the bank credits the Cheque amount only when it is cleared by the paying bank.

The cash balance shown by a firm on its books is called the book or ledger balance whereas the balance shown in its bank accunts is called the available or collected balance. The difference between the available balance and the ledger balance is referred to as the float.
There are two types of float viz., DISBURSEMENT FLOAT and COLLECTION FLOAT.
3.1 Disbursement Float

The amount fo Cheque issued but not presented for payment is kknown as the disbursement float. For example, suppose that ABC Company has a book balance as well as available balance of Rs 4 Lac with its bank, State Bank of India, as on March 31. On April 1 it pays Rs 1 Lac by Cheque to one of its suppliers and hence reduces its book balance by Rs. 1 Lac.

State Bank of India, however, will not debit ABC Company account till the Cheque has been presented for payment on, say, April 6. Until that happens the firm's available balance is greater thatn its book balance by Rs. 1 Lac. Hence, between April 1 and April 6 ABC Company has a disbursement float of Rs. 1 Lac.

Disbursement float = Firm's available Bank balance -Firm's book balance = Rs 4 Lac - Rs. 3 Lac = Rs.1 Lac.
3.2 Collection Float:

The amount of Cheque deposited in the banks, but not yet cleared, is known as the collection float.

For example, suppose that XYZ Company has book balance as well as available balance of Rs 5 Lac as on April 30. On May 1 XYZ Company receives a Cheque for Rs. 1.5 Lac from a customer which it deposits in the Bank. It increases its book balance by Rs. 1.5. Lac. However, this amoung is not available to ABC Company until its bank presents the Cheque to the customer's bank on, say, May 5. So, between May 1 and May 5 ABC Company has a collection float of (-) Rs. 1.5 Lac.

Collection float = Firm's avilable Bank Balance-Firm's book balance=Rs 5.0 Lac - Rs. 6.5 Lac = (-) Rs. 1.5 Lac.
3.3 Net Float:

The net float at a point of time is simply the overall difference between the firm's available bank balance and the balance shown by the ledger account of the firm. If the net float is positive, i.e., payment float is more than receipt float, then the available bank balance exceeds the book balance. However, if the available bank balance is less than the book balance, then the firm has net negative float. If a firm has positive net float (i.e. the payment float is more than the receipt float), it can issue more Cheque even if the net bank balance shown by the books of account may not be sufficient. A firm with a positive net float can use it to its advantage and maintain a smaller cash balance than it would have in the absence of the float. For example, a firm has a payment float of Rs. 1,00,000 and receipt float of Rs, 80,000. This firm has positive net float, which may be ascertained as follows:

Net float=Payment float-Receipt float = Rs. 1,00,000 - 80,000= Rs. 20,000. The course of action adopted by a firm to manage the payment and the receipt float is known as playing the float, which has emerged as an important technique of cash management in most of the firms. Float management helps avoiding stagnation of funds. Money paid by Cheque by customers to the firm but not yet available to the latter, as it is tied in the float is a stagnant money. Similarly, Cheque issued but no presented t the firm's bank is stagnant money. This can be used by a proper and careful float management.

Since what matters is the available balance, as a finance manager you should try to maximise the net float. This means that you should strive to speed up colections and delay disbursements.
4.1 Speeding Up Collections

The collection time comprises mailing time, Cheque processing delay, and the bank's availability delay as shown in Exhit 1.

When a company receives payments through Cheque that arrive by mail, all the three components of collection time are relevant. The financial manager shouls ttake steps for speedy recovery from debtors and for this purpose proper internal control system should be installed in the firmk. Once the credit sales have been effected, there should be a built-in mechanisim for timely recovery from the debtors. Periodic statements should be prepared to show the outstanding bills. Incentives offered to the customers for early / prompt payments should be well communicated to them. Once the cheques / drafts are received from customers, no delay should be there in depositing these receipts with the banks. The time lag in collection of receivables can be considerably reduced by managing the time taken by postal intermediaries and banks.

To speed up collection, companies may also use lockboxes and concentration banking which are essentially systems for expeditious decentralised collection.
4.1 Lock Boxes

Under a lock box system, customers are advised to mail their payments to special post office boxes called lockboxes, which are attended to by local collection banks, instead of sending them to corporate headquarters.

The local bank collects the Cheque from the lock box once or more a day, deposits the Cheque directly into the local bank account of the firm, and furnishes details to the firm.

Thus the lock box system (i) cuts down the mailing time, because Cheque are received at a nearby post office instead of at corporate headquarters, (ii) reduces the processing time because the company does not have to open the envelopes and deposit the Cheque for collection, and (iii) shortens the availability delay because the Cheque are typically drawn on local banks.

In India, the lock=box system is not popular. However, commercial banks usually provide service to their large clients of (i) collecting the cheques from the office of the client, and (ii) sending the high value cheques to the clearing system on the same day. Both these services help reducing the float of the large clients. However, these benefits are not free. Usually, the bank charges a fee for each cheque processed through the system. The benefits derived from the accelearation of receipts must exceed the incremental costs of the lock box system, or the firm would be better without it.

When is it worthwhile to have a lock box? The answer depends on the costs and benefits of maintaining the lock box. Suppose that your company is thinking of setting up a lock box. You gather the following information:
  • Average number of daily payments : 50
  • Average size of payment : Rs. 8000
  • Savings in mailing and processing time : 2 days
  • Annual rental for the lock box : Rs. 3000
  • Bank charges for operating the lock box : Rs. 72,000
  • Interest rate : 15%
The lock box will increase your company's collected balance by:

50 items day x Rs. 8,000 per item x 2 days saved = Rs 800,000

The annual benefit in the form of interest saving on account of this is:

Rs 800,000 x 0.15= Rs 120,000

The annual cost of the lock box is:

Rs 3,000 (rental) + Rs 72,000 (bank charges) = Rs 75,000

Sice the interest saving exceeds the cost of the lock box, it is advantageous to set up the lock box. More so because your company also saves on the cost of processing the Cheque internally.
4.1.2 Concentration Banking

A firm may open collection centres (banks) in different parts of the country to save the postal delays. This is known as concentration banking. Under this system, the collection centres are opened as near to the debtors as possible, hence reducing the time in dispatch, collection etc. The firm may instruct the customers to mail their payments to a regional collection centre / bank rathen than to the Central Office. The Cheque received by the regional collection centre are deposited for collection into a local bank account. Surplus funds from various local bank accounts are transferred regularly (mostly daily) to a concentration account at one of the company's principal banks. For effecting the transfer several options are available.

With the vast network of branches set up by banks regional / local collection centres can be easily established. To ensure that the system of collection works according to plan, it is helpful to periodically audit the actual transfers by the collecting banks and see whether they are are in conformity with the instruction given.

The concentration banking results in saving of time of collection, and hence results in better cash management. However, the selection of collection centres must be based on the volume of billing / business in a particular geographical area. It may be noted tha the concentration banking also involve a cost in terms of minimum cash balance required with a bank or in the form of normal minimum cost of maintaining a current account.

Concentration banking can be combined with the lock box arrangement to ensure that the funds are pooled centrally as quickly as possible.
4.1.3 Electronic Fund Transfer

The banking system has responded to the growing need to speed up the transfer of money from one firm to another. For example, the 'CHAPS' system in the UK (Clearing House Automated Payments System) permits same-day cheque clearance and CHIPS (Clearing House Interbank Payment System), a computerised network, enables the electronic transfer of international dollar payments. These systems provide two benefits to the larger firms, which use them. First, there is greter certainity as to when money will be received and section, they can reduce the time that money is in the banking system.

Companies can take other action to create a beneficial float. They could bank frequently to avoid having cheques remaining in the accounts office for more than a few hours. The could could also encourage customers to pay on time, or even in advance, of the receipt of goods and services by using the direct debit system through which money is automatically transferred from one account to another on a regular basis. Many UK consumers now pay direct debit. In return they often receive a small discount. From the producer's viewpoint this not only reduces the float but also avoids the onerous task of chasing late payers. Also retailers now have terminals which permit electronic funds transfer at the point of sale (EFTPOS) - money taken from customers accounts electronically using debit card.
4.2 Delaying Payments

Just as a firm can increase its net float by speeding up collections, it can also do so by slowing down disbursements. A common temptation is to increase the mail time. For example, Acme Ltd. may pay its suppliers in Cochin with Cheque sent from its Calcutta office and its suppliers in Ludhiana with Cheque mailed from its Chennai office. However such gimmicks provide only a short-term benefit and finally turn out ot be self-defeating when suppliers discover the poly and adjust their price and credit terms appropriately.

While maximising disbursement float is a questionable prictice, a firm can still payments. The following may be done in this respect.

Ensure that payments are made only when they fall due and not early. Centralise deisbursements. This helps in consolidating funds at the head office, scheduling payments more effectively, reducing unproductive cash ballances at region / local offices, and investing funds more productivity. However, care must be taken that the goodwill and credit rating of the firm is not affected.Payments to creditors need not be delayed otherwise it may be difficult to secure trade credits at a later stage.

Arrange with suppliers to set the due dates of their bills to match with company's receipts. Synchronisation of cash outflows with cash inflows helps a company to get greater mileage from its cash resources.
Electronic data interchange (EDI) refers to direct, electronic exchange of information between various parties. Financail EDI or FEDI, involves electronic transfer of information and funds between transacting parties . FEDI leads to elimination of paper invoices, paper Cheque, mailing handling and so on. Under FEDI, the seller sends the bill electronically to the buyer, the buyer electronically authorises its bank o make payment, and the bank transfers funds electornically to the account of the seller at a designed bank. The net effect is that the time requried to complete a business transacton is shortened considerably thereby virtually eliminating the float.

Currently one of the drawbacks of FEDI is that it is expensive and compelx to set up the drawbacks of FEDI is that it is India. Further, many partiesmay not ready or willing to participate in it. HOwever wih the advancements in technology and the growth of Internet, e-commerce costs will fall signicantly. This will induce more parties to participate in FEDI. As Ross (Wererfiled and Jordan Say: " As the use of FEDI inccreases (which it will) float management will evolve to fucus much more on issues surrounding computerozid information exchange and funds transfer.

Cash Management domestic firms to child's play compared with that in large multinational corporation operating in dozens of countries, each with its own currency, banking system and legal structure. Unilever, for example manufactures and sells allover the world. To operate effectively Unilver has numerous bank accounts so that some banking transactions can take place near to the point of business transaction can take place near to the point of business. Sales receipts from America will be paid into local banks there, likewise many operating expenses will be paid for with funds drawn from those same banks. The problem for Unilever is that some of those bank accounts will have high inflows and others high outflows, so interest could be payable on one while funds are lying idel or earning a low rate of return in another. Therefore, as well as taking advantage of the benefit of having local banks carry out local transactions, large firms need to set in place a co-ordinating system to ensure that funds are transferred from where there is surplus to where they are needed.

A single centralized cash management system is an unattainable idea for these companies, althogh they are edging towards it. For example, suppose that you are the treasurer of a large multination company with operations through out Europe. You could allow the separte business to manage their own cash but that would be costly and would almost certainly result in each one accumalating little hoards of cash. The solution is to set up a regional system. In this case the company establishes a local concentration account with a bank in each country. Then any surplus cash is swept daily into central multicurrency accounts in London or another European banking center. This cash is then invested in marketable securites or used to finance any subsidiaries that have a cash shortage.

Payments also can be made out of the regional center. For example, to pay wages in each European country, the company just needs to send its principal bank a computer file with details of the payment to be made, the bank then finds the least costly way to transfer the for the funds to be credited on the correct day to the employees in each country.

Most large multinationals have several banks in each country, but the more banks they use, the less control they have over their cash balances. So development of regional cash management system favours banks that can offer a worldwide branch network.

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