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Managing Float

Several kinds of delay create float, so people in the cash management business refer to several kinds of float. Figure 2.5 shows the three sources of float:

І The time that it takes to mail a check.

І The time that it takes the company to process the check after it has been received.

І The time that it takes the bank to clear the check and adjust the firm`s account.

The total collection time is the sum of these three sources of delay

Delays that help the payer hurt the recipient. Recipients try to speed up collections. Payers try to slow down disbursements. Both attempt to minimize net float.

You probably have come across attempts by companies to reduce float in your own financial transactions. For example, some stores now encourage you to pay bills with your bank debit card instead of a credit card. The payment is automatically debited from your bank account on the day of the transaction, which eliminates the considerable float you otherwise would enjoy until you were billed by your credit card company and paid your bill. Similarly, many companies now arrange preauthorized payments with their customers. For example, if you have a mortgage payment on a house, the lender can arrange to have your bank account debited by the amount of the payment each month. The funds are automatically transferred to the lender. You save the work of paying the bill by hand, and the lender saves the few days of float during which your check would have been processed through the banking system. The nearby box discusses tactics that banks use to maximize their income from float.

SPEEDING UP COLLECTIONS

One way to speed up collections is by a method known as concentration banking. In this case customers in a particular area make payments to a local branch office rather than to company headquarters. The local branch office then deposits the checks into a local bank account. Surplus funds are periodically transferred to a concentration account at one of the company`s principal banks.

Concentration banking reduces float in two ways. First, because the branch office is nearer to the customer, mailing time is reduced. Second, because the customers are local, the chances are that they have local bank accounts and therefore the time taken to clear their checks is also reduced. Another advantage is that concentration brings many small balances together in one large, central balance, which then can be invested

in interest-paying assets through a single transaction. For example, when Amoco streamlined its U.S. bank accounts, it was able to reduce its daily bank balances in non Јinterest-bearing accounts by almost 80 percent.1

Unfortunately, concent ration banking also involves additional costs. First, the company is likely to incur additional administrative costs. Second, the company`s local bank needs to be paid for its services. Third, there is the cost of transferring the funds to the concentration bank. The fastest but most expensive arrangement is wire transfer, in which funds are transferred from one account to another via computer entries in the accounts.

A slower but cheaper method is a depository transfer check, or DTC. This is a preprinted check used to transfer funds between specified accounts. The funds become available within 2 days.

Wire transfer makes more sense when large funds are being transferred. For example, at a daily interest rate of .02 percent, the daily interest on a $10 million payment would be $2,000. Suppose a wire transfer costs $10. It clearly would pay to spend $10 to save 2 days` float. On the other hand, it would not be worth using wire transfer for just $5,000. The extra 2 days` interest that you pick up amounts to only $2, not nearly

enough to justify the extra expense of the wire transfer.