Proper Cash ManagementProper cash management requires that the company know how much cash it needs, as well as how much it has and where that cash is at all times. This is especially essential in an inflationary environment. Cash refers to currency and demand deposits. Cash management involves having the optimum, neither excessive nor deficient, amount of cash on hand at the right time.


This post provides some tips, tricks and wisdoms to proper cash management, backed up by case examples. Follow on…


The objective of cash management is to invest excess cash for a return while retaining sufficient liquidity to satisfy future needs. The financial manager must plan when to have excess funds available for investment and when money needs to be borrowed.

The amount of cash to be held depends upon the following factors:

  • Cash management policies
  • Current liquidity position
  • Management’s liquidity risk preferences
  • Schedule of debt maturity
  • The firm’s ability to borrow
  • Forecasted short- and long-term cash flow
  • The probabilities of different cash flows under varying circumstances


The company should not have an excessive cash balance since no return is being earned upon it. The least amount of cash a firm should hold is the greater of (1) compensating balances (a deposit held by a bank to compensate it for providing services) or (2) precautionary balances (money held for emergency purposes) plus transaction balances (money needed to cover checks outstanding).

Cash management also requires knowing the amount of funds available for investment and the length of time for which they can be invested. A firm may invest its funds in the following:

  • Time deposits, including savings accounts earning daily interest, long-term savings accounts, and certificates of deposit
  • Money market funds, which are managed portfolios of short-term, high-grade debt instruments such as Treasury bills and commercial paper
  • Demand deposits that pay interest
  • U.S. Treasury securities


When cash receipts and disbursements are highly synchronized and predictable, a firm may keep small cash balance. The financial manager must accurately forecast the amount of cash needed, its source, and its destination. These data are needed on both a short- and a long-term basis.

Forecasting assists the manager in properly timing financing, debt repayment, and the amount to be transferred between accounts.


In deciding whether to adopt a cash management system, the financial manager should consider its associated costs versus the return earned from implementation of the system. Costs related to cash management systems include bank charges, financial manager’s time, and office employee salaries.

Some cash management systems use the firm’s computer to make transactions with the computers of banks and money market funds. Computer systems are also useful for purchasing and selling securities in the money market.

Companies with many bank accounts should guard against accumulating excessive balances.

Less cash needs to be kept on hand when a company can borrow quickly from a bank, such as under a line of credit agreement, which permits a firm to borrow instantly up to a specified maximum amount. A company may also find some cash unnecessarily tied up in other accounts, such as advances to employees. Excess cash should be invested in marketable securities for a return.

Note, however, that cash in some bank accounts may not be available for investment. For instance, when a bank lends money to a company, the bank often requires the company to keep funds on hand as collateral. This deposit is called a compensating balance, which in effect represents restricted cash for the company.

Holding marketable securities serves as protection against cash shortages. Companies with seasonal operations may buy marketable securities when they have excess funds and then sell the securities when cash deficits occur. A firm may also invest in marketable securities when funds are being held temporarily in anticipation of short-term capital expansion. In selecting an investment portfolio, consideration should be given to return, default risk, marketability, and maturity date.

The thrust of cash management is to accelerate cash receipts and delay cash payments. Each bank account should be analyzed as to its type, balance, and cost so that corporate return is maximized.



Acceleration of Cash Inflow

To accelerate cash inflow, the financial manager must:

  • know the bank’s policy regarding fund availability;
  • know the source and location of company receipts; and
  • devise procedures for quick deposit of checks received and quick transfer of receipts in outlying accounts into the main corporate account.


The various types of check processing delays that must be analyzed are:

  • mail float—the time required for a check to move from a debtor to a creditor;
  • processing float—the time it takes for a creditor to deposit the check after receipt; and (3) deposit collection float—the time required for a check to clear.


Note: Electronic data exchange (EDI), or financial EDI (FEDI), significantly reduces or eliminates a float. EDI refers to the growing practice of direct, electronic information exchange between all types of businesses, thereby shortening the length of time required to initiate and complete a business transaction.


Mail float can be minimized by having the collection center located near the customer. Local banks should be selected to speed the receipt of funds for subsequent transfer to the central corporate account. As an alternative, strategic post office lockboxes may be used for customer remissions. The local bank collects from these boxes periodically during the day and deposits the funds in the corporate account. The bank also furnishes the company with a computer listing of payments received by account and a daily total. Because the lockbox system has a significant per-item cost, it is most cost-effective with low-volume, high-dollar remissions. However, the system is becoming increasingly more available to companies with high-volume, low-dollar deposits as technological advances (such as machine-readable documents) lower the per-item cost of lockboxes.

Before a lockbox system is implemented, the company should make a cost–benefit analysis that considers the average dollar amount of checks received, the costs saved by having lockboxes, the reduction in mailing time per check, and the processing cost.



Lie Dharma Corporation obtains average cash receipts of $200,000 per day. It usually takes 5 days from the time a check is mailed to its availability for use. The amount tied up by the delay is:

5 days x $200,000 = $1,000,000



It takes Putra Corporation about 7 days to receive and deposit payments from customers. Therefore, a lockbox system is being considered. It is expected that the system will reduce the float time to 5 days. Average daily collections are $500,000. The rate of return is 12 percent.

The reduction in outstanding cash balances arising from implementing the lockbox system is:

2 days x $500,000 = $1,000,000


The return that could be earned on these funds is:

$1,000,000 x 0.12 = $120,000


The maximum monthly charge the company should pay for this lockbox arrangement is therefore:

$120,000/12 = $10,000



Dharma Putra Corporation is exploring the use of a lockbox system that will cost $100,000 per year. Daily collections average $350,000. The lockbox arrangement will reduce the float period by 2 days. The firm’s rate of return is 15 percent.

The cost–benefit analysis is shown below:

Return on early collection of cash
0.15 x 2 x $350,000                        = $105,000
Cost                                                 = $100,000
Advantage of lockbox                      = $   5,000
A corporate financial manager should determine whether it would be financially advantageous to split a geographic collection region into a number of parts.


Lie Dharma Company has an agreement with Charter Bank in which the bank handles $3 million in collections a day and requires a $700,000 compensating balance. Lie is thinking of canceling the agreement and dividing its western region so that two other banks will handle its business instead. Bank A will handle $1 million a day of collections, requiring a compensating balance of $300,000, and bank B will handle the other $2 million a day, asking for a compensating balance of $500,000. Lie’s financial manager anticipates that collections will be accelerated 14 day if the western region is divided. The company’s rate of return is 14 percent.

The financial manager decided that the new arrangement should be implemented, based on the following analysis:

Acceleration in cash receipts                       = $750,000
$3 million per day  1/4 day

Additional compensating balance required = $100,000
Increased cash flow                                     = $650,000
Rate of return                                                       x 0.14
Net annual savings                                       = $  91,000


Concentration banking should also be considered for use. With this method funds are collected by several local banks and transferred to a main concentration account in another bank. The transfer of funds between banks should be accomplished through the use of “depository transfer checks (DTCs)” or wire transfers. In the DTC arrangement, there exists a resolution statement with the bank in which signatureless checks are allowed to be deposited. As the initial banks collect the funds, information is immediately transferred to the concentration bank, which then issues a DTC to collect the outlying funds. The funds may be available the same day.

Once remissions have been accelerated, freed cash should be used for investment in marketable securities or to pay off short-term debt. Thus, the freed cash will generate interest revenue to the business. The revenue derived can be determined for a given month by multiplying the monthly average accounts receivable balance times the associated monthly interest rate (i.e., the interest rate on marketable securities or the interest rate applicable to short-term debt).


A firm’s weekly average cash balances are as follows:

Week       Average Cash Balance

1                            $12,000
2                            $17,000
3                            $10,000
4                            $15,000
Total                      $54,000


The monthly average cash balance is:

$54,000/4 = $13,500


If the annual interest rate is approximated at 12 percent, the monthly return earned on the average cash balance is:

$13,500 x 0.1 = $135


For a cash acceleration system to be feasible, the return earned on the freed cash must exceed the cost of the system.


Delay of Cash Outflow

There are various ways to delay cash disbursements, including:

  • Using drafts to pay bills since drafts are not due on demand. When a bank receives a draft it must return the draft to the issuer for acceptance prior to payment. When the company accepts the draft, it then deposits the required funds with the bank; hence, a smaller average checking balance is maintained.
  • Mailing checks from post offices having limited service or from locations where the mail must go through several handling points, lengthening the payment period.
  • Drawing checks on remote banks or establishing cash disbursement centers in remote locations so that the payment period is lengthened. For example, someone in New York can be paid with a check drawn on a California bank.
  • Using credit cards and charge accounts in order to lengthen the time between the acquisition of goods and the date of payment for those goods.
  • Disbursing sales commissions when the receivables are collected rather than when the sales are made.
  • Maintaining a zero balance account (ZBA) where zero balances are established for all of the company’s disbursing units. These accounts are in the same concentration bank. Checks are drawn against these accounts, with the balance in each account never exceeding $0. Divisional disbursing authority is thus maintained at the local level of management. The advantages of zero balance accounts are better control over cash payments, reduction in excess cash balances held in regional banks, and a possible increase in disbursing float.
  • Using a controlled disbursement account. With this system, almost all payments that must be made are known in the morning. The bank informs the firm of the total, and the firm transfers (usually by wire) the amount needed.



Every 2 weeks, company X disburses checks that average $500,000 and take 3 days to clear. How much money can the company save annually if it delays transfer of funds from an interest-bearing account that pays 0.0384 percent per day (annual rate of 14 percent) for those 3 days?

The interest for 3 days is:

$500,000 x (0.000384 x 3) = $576


The number of 2-week periods in a year is:

52 weeks/ 2 weeks = 26


The savings per year is:

$576 x 26 = $14,976


Opportunity Cost of Forgoing a Cash Discount

An opportunity cost is the net revenue lost by rejecting an alternative action. A firm should typically take advantage of a discount offered by a creditor because of the associated high opportunity cost. For example: if the terms of sale are 2/10, net/30, the customer has 30 days to pay the bill but will get a 2 percent discount if he or she pays in 10 days. Some companies use seasonal datings such as 2/10, net/30, July 1 dating. Here, with an invoice dated July 1, the discount can be taken until July 10.

The following formula may be used to compute the opportunity cost in percentage, on an annual basis, of not taking a discount:

Opportunity cost = [discount percent / (100 x discount percent)] x 360/N

where N=the number of days payment can be delayed by forgoing the cash discount
              =days credit is outstanding – discount period


The numerator of the first term (discount percent) is the cost per dollar of credit, whereas the denominator (100 discount percent) represents the money made available by forgoing the cash discount. The second term represents the number of times this cost is incurred in a year.


The opportunity cost of not taking a discount when the terms are 3/15, net/60 is computed as follows:

Opportunity cost = [3 / (100 – 3) x 360]/ (60 – 15)
                            = [3/ 97] x [360/ 45] = 24.7%