Chapter 10 Cash Concentration

1. Chapter 10Cash Concentration • Order Order Sale Payment Sent Cash • Placed Received Received • Accounts Collection • < Inventory > < Receivable > < Float > • Time ==> • Accounts Disbursement • < Payable > < Float > • Invoice Received Payment Sent Cash Disbursed

2. Learning Objectives • Understand the need for a cash concentration system. • Formulate a cash transfer decision model. • Understand the advantages and disadvantages of the different cash transfer tools.

3. Basic Structure • Exhibit 10.1 • Cash transfer tools • Initiation of the transfer • System costs • Benefits of the system

4. Central Concentration Bank Wire or ACH Lockbox Regional Concentration Bank 1 Regional Concentration Bank 2 DTC or ACH Gathering Bank 1 Gathering Bank 2 Gathering Bank n Gathering Bank 1 Gathering Bank 2 Gathering Bank n Customers... Customers... Exhibit 10.1 Lockbox

5. Cash Transfer Tools • Depository transfer checks - DTC (0-2 day) • Paper • Processed via normal check clearing channels • Forwarded to concentrating bank while checks clear • ACH or Electronic Depository Transfer – EDT (1 day) • Concentration bank debits gathering bank account • Wire transfer (Immediate) • Expensive • Requires collected balances

6. Initiation of the Transfer • Decentralized • Centralized

7. System Costs • Opportunity cost of idle balances • Amount above RCB earns nothing • Amount up to RCB earns ECR (earnings credit rate) • Transfer costs • EDT < DTC < Wire • Administrative costs • Cash manager must receive and review deposit reports and oversee system

8. Benefits of the System • Economies of scale • Rate on large investments is greater than the rate earned on many small investments • Enhanced visibility and control of balances • Concentrated balances are more easily managed than many scattered accounts • Dual balance possibilities • Deposit may be available at concentration bank before the debit clears the gathering bank

9. The Cash Flow Timeline T1 T2 T3 T4 T5 T6 Debit field bank account Balance available at the concentration bank Transfer initiated Collected funds at the field bank Deposit reported Original deposit at field bank

10. Cash Transfer Scheduling • Complicating factors • Objective: minimize transfer costs • Transfer rules

11. Complicating Factors • Minimum transfer balance • Set incremental cost = Days Saved x ((k - ecr(1-rr)) x TBAL • Solve for TBAL • TBAL = Incremental cost/DS x [k - ecr(1-rr)/365] • Fluctuating daily deposits • Deposits with different availabilities • Availability of deposits v.s. clearing of transfer instrument • Weekends

12. Objective: Minimize Transfer Costs • Subject To: adequate bank compensation • TC = Fee + (k x (ACB - RCB))Where:RCB = (SC - Fee)/ecr(1-rr) • See page 352 for definition of terms • Note that time periods must be the same

13. Transfer Rules • Daily transfer: transfer the daily deposit • Managing about a target: • one-time transfer out to earn interest • reduces the number of transfers • Anticipation: initiate transfer prior to deposit • risky

14. Summary • A collection system such as a lockbox necessitates the development of a concentration system. • This chapter discussed the structure of a cash concentration system and identified the advantages and disadvantages. • The chapter developed an objective function for the cash transfer scheduling problem. • Three transfer scheduling rules were identified and discussed. • The chapter concluded by comparing cash concentration characteristics.