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Chapter 19
CASH AND LIQUIDITY MANAGEMENT
CHAPTER WEB SITES
Section
Web Address
CHAPTER ORGANIZATION
19.1 Reasons for Holding Cash
19.2 Understanding Float
19.3 Cash Collection and Concentration
19.4 Managing Cash Disbursements
19.5 Investing Idle Cash
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Appendix 19A Determining the Target Cash Balance
ANNOTATED CHAPTER OUTLINE
19.1. Reasons for Holding Cash
A. The Speculative and Precautionary Motives
Speculative motive – take advantage of unexpected opportunities
Precautionary motive – cash for emergencies
Lecture Tip: What is needed to satisfy the speculative and
B. The Transaction Motive
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C. Compensating Balances
Cash balances held as part of a loan agreement or as compensation
for bank services received
Lecture Tip: A compensating balance requirement serves both as
D. Costs of Holding Cash
The opportunity cost of holding cash is the return that could be
earned by investing the cash in other assets. However, there is also
a cost to converting between cash and other assets. The optimal
cash balance will consider the trade-off between these costs to
minimize the overall cost of holding cash.
Lecture Tip: It may be helpful to have students consider how they
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E. Cash Management versus Liquidity Management
19.2. Understanding Float
A. Disbursement Float
B. Collection Float and Net Float
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Lecture Tip: It may help to personalize the issue of float. Ask the
C. Float Management
The three components of float are:
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Example – Continuous Collections: Suppose average daily checks
arriving at Hector Company amount to $2,000. The checks take an
average of three days to arrive in the mail, one day to process and
two days to be credited to the bank account. The total collection
delay is six days, and the average daily float is 6*2000 = $12,000.
Eliminating all delays would free up $12,000; eliminating one
day’s delay would free up $2,000.
Real-World Tip: The Expedited Funds Availability Act (EFAA)
Cost of Collection Float
The benefit of reducing collection delays is directly reflected in the
change in average daily float. Every dollar reduction in average
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Lecture Tip: The concept of net float can be emphasized with an
example that illustrates the changes in the balance sheet that result
The accounts receivable debit balance is reduced by $100,000
(source of funds) and the accounts payable account is increased by
$80,000 (source of funds). The net source of funds equals the
change in float, and the additional cash can be used to decrease
the external financing required.
Real-World Tip: The Institution Investor (September, 1985)
D. Electronic Data Interchange and Check 21: The End of Float?
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19.3. Cash Collection and Concentration
A. Components of Collection Time
B. Cash Collection
C. Lockboxes
D. Cash concentration
E. Accelerating Collections: An Example
Chapter 19 – Cash and Liquidity Management
19.4. Managing Cash Disbursements
A. Increasing Disbursement Float
Ethics Note: You may wish to emphasize the importance of ethical
behavior in this area of cash management. Because transactions
B. Controlling Disbursements
Minimize liquidity needs by keeping a tight rein on disbursements
through any ethical means possible
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19.5. Investing Idle Cash
A. Temporary Cash Surpluses
B. Characteristics of Short-Term Securities
asset can be bought or sold quickly with little effect on the current
C. Some Different Types of Money Market Securities
U.S. treasury bills, short-term tax exempts, commercial paper,
CDs, and repos are among the most common money market
securities.
19.6. Summary and Conclusions
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APPENDIX 19A
DETERMINING THE TARGET CASH BALANCE
Target cash balance – the desired cash balance as determined by
the trade-off between carrying costs and storage costs.
A. The Basic Idea
Define:
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Example: Hermes Co. has cash outflows of $500 per day, the
interest rate is 10% and the fixed transfer cost is $25.
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When cash reaches U*, the firm transfers cash (buys securities)
D. Implications of the BAT and Miller-Orr Models
From both:
E. Other Factors Influencing the Target Cash Balance