wire transfer.

A wire transfer is

simply a telephone-like communication, which, via bookkeeping entries, removes funds from

a payor bank account and deposits them in an account of a payee bank. Wire transfers may

be made through the Federal Reserve Wire System (Fedwire) or through a private wire

system. Funds are considered available upon receipt of the wire transfer. Though a DTC

costs only 50 cents or so for processing, sending, and receiving, charges for a wire transfer

typically range around $15. As a result of their relatively high cost, wire transfers are generally

reserved for moving only large sums of money or when speed is of the essence.

S-l-o-w-i-n-g D-o-w-n Cash Payouts

Whereas one of the underlying objectives of cash management is to accelerate collections, still

another objective is to slow down cash disbursements as much as possible. The combination

of fast collections and slow disbursements will result in increased availability of cash.

l l l “Playing the Float”

The cash figure shown on a firm’s books seldom represents the available amount of cash that

the firm has in the bank. In fact, the funds available in the bank are generally greater than the

Part 4 Working Capital Management

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••

“The times, they are a-changin.”

Admittedly, Bob Dylan didn’t have payment processes

in mind when he penned those words, but they aptly

describe the ongoing evolution of these key corporate

functions, driven by shifts in legislation and technology as

well as an ever-increasing focus on efficiency and control.

Changing regulations have facilitated the conversion

of many paper payments to electronic ones. Case in

point: Check 21. The law allows the use of substitute

checks – as long as they meet certain requirements – as

the legal equivalent of the original paper. Today, just two

years after the law went into effect, 6.2 million payments,

accounting for more than $20 million, are processed in

this way on an average day, according to the Federal

Reserve.

Those numbers are expected to rise, although growth

estimates vary. Industry analysts predict that the proportion of checks processed as image exchanges,
currently

between 10 percent and 30 percent, will grow to somewhere between 60 percent and 90 percent by
2010.

On March 16 of next year [2007], back-office conversion goes into effect. This will allow retailers and
other

businesses that accept checks at point-of-sale or billpayment locations to convert eligible checks to ACH

debits in their back offices.

In 2008, the provisions of the single euro payments

area (SEPA) start to phase in. SEPA will replace Europe’s

multiple national payment infrastructures with a single

platform. Organizations will be able to use that resource

to process payments that cross national boundaries at a

cost similar to that charged for domestic payments.

Improved technical tools are also impacting payment

processes. For example, new software packages can help

treasuries automate exception processing. In the past,

businesses had to manually research checks that arrived

without the payer’s account number. Now software can

capture and retain the check writer’s name so that future

payments can be applied to the correct account even if

the account number is not on the check.

Companies that use lockbox services are finding that

their bank or financial institution can electronically capture not only checks but also the supporting
documents,

such as invoices, that accompany them. That makes

researching exceptions more efficient and reduces the

need to store paper payment documents.

In addition, treasury information systems increasingly

provide greater visibility into the monies companies

receive. For example, some tools provide daily records

of the payments coming in to an organization’s bank

accounts around the globe.

Payment Processing: The Sea Change Continues

Source: Adapted from Karen M. Kroll, “Payment Processing: The Sea Change Continues,” Business
Finance (December 2006), Innovations in

Finance: CFOs Best Solutions Supplement. (www.bfmag.com) Copyright © 2006 by Penton Media, Inc.
Used by permission. All rights reserved.

Wire transfer A

generic term for

electronic funds

transfer using a twoway communications

system, such

as Fedwire.

FUNO_C09.qxd 9/19/08 16:58 Page 228

2

In many instances, shortly after a creditor puts a check in the mail, an invoice is considered paid. The
“mailbox rule,”

a custom since 1818, sets the postmark on the envelope as the date of payment. However, not everyone
adheres to

the “mailbox rule.” Many firms consider the payment date to be the date of receipt of a check at their
lockbox (or

other designated remittance center). Therefore creditors need to familiarize themselves with the
specific credit and

payment terms of each supplier.

balance shown on the company’s books. The dollar difference between the company’s bank

balance and its book balance of cash is called net float (or sometimes, just plain float). Net

float is the result of delays between the time checks are written and their eventual clearing by

the bank. It is very possible for a company to have a negative cash balance on its books and a

positive bank balance, because checks just written by the company may still be outstanding.

If the size of net float can be estimated accurately, bank balances can be reduced and the funds

invested to earn a positive return. This activity has been referred to by corporate treasurers as

“playing the float.”

l l l Control of Disbursements

Essential to good cash management is a company’s control of disbursements that will

slow down cash outflows and minimize the time that cash deposits are idle. A company with

multiple banks should be able to shift funds quickly to banks from which disbursements are

made to prevent excess balances from temporarily building up in a particular bank. The idea

is to have adequate cash at the various banks, but not to let excess balances build up. This

requires daily information on collected balances. Excess funds may then be transferred to

disbursement banks, either to pay bills or to invest in marketable securities. Many companies

have developed sophisticated computer systems to provide the necessary information and to
transfer excess funds automatically. Instead of developing one’s own system, a firm can hire

outside computer services to provide the described functions.

One procedure for tightly controlling disbursements is to centralize payables into a single

account (or a small number of accounts), presumably at the company’s headquarters. In this

way, disbursements can be made at the precise time they are desired. Operating procedures

for disbursements should be well established. If cash discounts are taken on accounts payable,

the firm should send payment at the end of the cash discount period.2 But, if a discount is not

taken, the firm should not pay until the final due date in order to have maximum use of cash.

(We will have more to say on whether or not to take a cash discount for prompt payment in

Chapter 11.)

Payable Through Draft (PTD). A means for delaying disbursements is through the use of

payable through drafts (PTDs). Unlike an ordinary check, the payable through draft is not

payable on demand. When it is presented to the issuer’s bank for collection, the bank must

present it to the issuer for acceptance. The funds are then deposited by the issuing firm to

cover payment of the draft. The advantage of the draft arrangement is that it delays the time

the firm actually has to have funds on deposit to cover the draft. Consequently, it allows the

firm to maintain smaller balances at its banks. A disadvantage of a draft system is that certain

suppliers may prefer checks. Also, banks do not like to process drafts because they often

require special manual attention. As a result, banks typically impose a higher service charge to

process drafts than they do to process checks.

Payroll and Dividend Disbursements. Many companies maintain a separate account for

payroll disbursements. To minimize the balance in this account, the firm must predict when

the payroll checks issued will be presented for payment. If payday falls on a Friday, not all of

the checks will be cashed on that day. Consequently, the firm does not need to have funds on

deposit to cover its entire payroll. Even on Monday, some checks will not be presented
because of delays in their deposit. Based on its experience, the firm should be able to construct

a distribution of when, on the average, checks are presented for collection. An example is

shown in Figure 9.3. With this information, the firm can approximate the funds it needs

9 Cash and Marketable Securities Management

229

••

Payable through draft

(PTD) A check-like

instrument that is

drawn against the

payor and not against

a bank as is a check.

After a PTD is

presented to a bank,

the payor gets to

decide whether to

honor or refuse

payment.

Net float The dollar

difference between

the balance shown

in a firm’s (or

individual’s)

checkbook balance

and the balance on

the bank’s books.

FUNO_C09.qxd 9/19/08 16:58 Page 229

to have on deposit to cover payroll checks. Many firms also establish a separate account for

dividend payments, similar to the one used for payroll. Here, too, the idea is to predict when

dividend checks will be presented for payment so that the firm can minimize the cash balance

in the account.

Zero Balance Account (ZBA). The use of a zero balance account (ZBA) system, which is

offered by many major banks, eliminates the need to accurately estimate and fund each individual
disbursement account. Under such a system, one master disbursing account services all

other subsidiary accounts. When checks are cleared at the end of each day, the bank automatically
transfers just enough funds from the master account to each disbursement account

(e.g., one for payroll, one for payables, etc.) to just cover checks presented.3 Thus a zero

ending balance is maintained each day in all but the master account. Besides improving control over
disbursements, a zero balance account system eliminates idle cash balances from

all subsidiary accounts. The firm’s cash manager still needs to forecast anticipated checkclearing times
so that the master account will have sufficient cash to service the subsidiary

disbursement accounts. But, by the law of large numbers, multiple errors tend to cancel each

other out, and a fair approximation of the cash needed to be maintained in the master account

can be made.

l l l Remote and Controlled Disbursing

Taking advantage of inefficiencies in the check-clearing processes of the Federal Reserve

System and of certain commercial banks, as well as inefficiencies in the postal system, a firm

may maximize the time the checks it writes remain outstanding. Various models have been

proposed to maximize disbursement float through the selection of geographically optimal

disbursing banks. The idea is to locate disbursing banks and to draw checks on them in a way

that will maximize the time a check will remain outstanding. A firm using remote disbursement might,
for example, mail a check to a supplier in Maine that was drawn on a bank in
Helena, Montana.

By maximizing disbursement float, the firm can reduce the amount of cash it holds and

employ these unused funds in more profitable ways. One firm’s gain, however, is another’s

loss. Maximizing disbursement float means that suppliers will not have collectible funds as

early as would otherwise be the case. To the extent that suppliers look with disfavor on such

payment habits, supplier relations may be hurt by remote disbursing.

Part 4 Working Capital Management

230

••

Figure 9.3

Percentage of payroll

checks collected

Alternatively, zero balance accounts at one or more banks could be funded through wire transfers from
a central

account at another bank (often a concentration bank).

Zero balance account

(ZBA) A corporate

checking account in

which a zero balance

is maintained. The

account requires

a master (parent)

account from which

funds are drawn

to cover negative
balances or to which

excess balances

are sent.

Disbursement float

Total time between

the mailing of a check

by a firm and the

check’s clearing the

firm’s checking

account.

Remote disbursement

A system in which the

firm directs checks to

be drawn on a bank

that is geographically

remote from its

customer so as to

maximize checkclearing time.

FUNO_C09.qxd 9/19/08 16:58 Page 230

9 Cash and Marketable Securities Management

231

••

On May 2, 1985, E. F. Hutton, the nation’s fifth largest brokerage firm at that time, pleaded

guilty to 2,000 felony counts of mail and wire fraud. Hutton had been engaging in “extreme”

float-creating practices – a number involving remote disbursing. This case prompted many
companies to review all of their cash management practices. In many cases these reviews led

companies to adopt formal cash management policies and codes of conduct. In some cases,

remote disbursing was considered to be unethical in that it was a cash management technique

designed expressly to delay normal check clearing.

A practice related to remote disbursement, but having fewer negative connotations, is

called controlled disbursement. It too may make use of small, out-of-the-way disbursement

banks (or branches of large banks). However, the primary reason for choosing these particular
disbursement banks is that late presentments (checks received after the initial daily

shipment of checks from the Federal Reserve) are minimal. This fact allows the firm to

better predict disbursements on a day-to-day basis.

Electronic Commerce

Currently, most business documents and payments in the United States are in paper form

and exchange generally takes place through the US mail. Electronic commerce (EC) – the

exchange of business information in an electronic format – offers an alternative to this

paper-based system. At one end of the electronic commerce spectrum, we find unstructured

electronic messaging such as facsimile transmission (fax) and electronic mail (e-mail). At the

other end, the highly structured messaging known as electronic data interchange (EDI) is

found. Our focus in this section is on EDI, especially how EDI relates to a company’s collections and
disbursements.

l l l Electronic Data Interchange

Electronic data interchange (EDI) involves the transfer of business information (e.g.,

invoices, purchase orders, and shipping information) in a computer-readable format. EDI not

only involves direct, computer-to-computer data movement via communication links but

Controlled

disbursement

A system in which the

firm directs checks to

be drawn on a bank

(or branch bank) that

is able to give early

or mid-morning

notification of the

total dollar amount of

checks that will be

presented against its

account that day.

Electronic commerce

(EC) The exchange of

business information

in an electronic

(nonpaper) format,

including over the

Internet.

Electronic data

interchange (EDI)

The movement of

business data

electronically in a

structured, computerreadable format.

The payments systems for various countries differ. For

example, the lockbox system so widely used in the

United States is not as well developed in other countries.

A foreign lockbox arrangement is generally more costly

than is a US arrangement. As lockbox networks are

developed in Europe and Asia, however, the cost should

come down. Now the cost/benefit ratio is not as favorable as typically occurs in the United States.

Many payments in Europe are through a postal clearing service. In this regard, the giro system permits
automatic payments through the postal service. The service

is instructed by the payer to transfer funds to a payee’s

account, and advices are sent to both parties. No physical check is used. This service is apart from the
banking

system.

Checks on the banking system are also used for payments, and their use is growing. However, for
recurring

payments the giro payments system is the most widely

used. Payments also can be through wire transfers, usually with a one-day lag in availability of funds if
domestic

currency is involved and two-day if the currency is foreign.

For multinational companies, cash and marketable

securities may be kept in multiple currencies. Many

companies maintain liquidity in the country where

investment takes place and/or where the sourcing of

the product occurs. The marketable securities position

of such a company is part of a broader management of

currency risk exposure, which we address in Chapter 24.

It is important that the financial manager understand

the many differences in institutional aspects of overseas payment and investment of excess funds. We
have
touched on only a few, but the globalization of business

and finance dictates a familiarity if the company is to

compete in the world arena.

International Cash Management

FUNO_C09.qxd 9/19/08 16:58 Page 231

Part 4 Working Capital Management

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••

also the physical delivery among businesses of electronic data storage items such as computer

tapes, disks, and CD-ROMs.

Electronic funds transfer (EFT) forms an important subset of EDI. The distinguishing

feature of EFT is that a transfer of value (money) occurs in which depository institutions

(primarily banks) send and receive electronic payments. Examples of domestic EFT include

automated clearing house (ACH) transfers and wire transfers. Internationally, EFT may

involve instructions and transfers by way of the Society for Worldwide Interbank Financial

Telecommunication (SWIFT) and the Clearing House Interbank Payments System

(CHIPS).

A major boost to EFT in the United States came in January 1999, when a new regulation

went into effect requiring that all federal government payments – except for tax refunds and

situations where waivers are granted – be made electronically. Direct deposit of payments

through EFT should prove more secure than paper checks and, typically, be more convenient.

EFT payments are also expected to provide cost savings for the government.

A second major subset of EDI is known as financial EDI (FEDI). FEDI involves the

exchange of electronic business information (nonvalue transfer) between a firm and its

bank or between banks. Examples include lockbox remittance information and bank balance
information.

Even for businesses that have implemented electronic data interchange and funds transfer

techniques, many of their transactions will still be at least partially paper-based. For example,

a company could transact all of its business activities using EDI and yet make some payments

with paper checks. Alternatively, some of a firm’s data interchange may be paper-based,

whereas ACH and wire transfers might handle all of its payments.

The main benefit to companies is that SEPA will allow

cheaper and ultimately faster payments to be made in

euros.

When the euro was first introduced in 1999, it was

simply the first step toward a pan-European

payments system. Now the finishing touches on the

infrastructure necessary to achieve that vision are being

put in place. SEPA, or the Single Euro Payments Area,

is scheduled to be introduced in January of 2008 and

fully implemented by 2010.

Mandated by the European Union, SEPA will require

banks to price all cross-border settlements in euros at

the same level as comparable domestic products. For

the first time, treasurers will have access to a fluid crossborder payment framework at the low-value, or
ACH,

level.

The main benefit is that SEPA will allow cheaper and

ultimately faster payments to be made in euros. Why? For

starters, fees will become more transparent, says Michael

Wagner, a director in the London office of consultancy

Mercer Oliver Wyman, and that will create “pressure to

move to parity.” Moreover, SEPA will allow companies

to reduce their banking relationships and rethink their

treasury-center locations. “What treasurer would not like

to see [his] accounts consolidated from 30 to five?” asks

Alan Koenigsberg of JPMorgan Chase’s Treasury Services.

For the banks, however, the conversion will not be

cheap. A 2006 Boston Consulting Group study estimates

that the cost to make national banking systems in the EU

interoperable by 2008 could run to US$650m. The next

step – eliminating or converting all domestic schemes by

2010 – will take another US$6.5 bn. In addition, Wagner

predicts a “10% to 30% erosion in fees” once SEPA is

under way. The result could be more consolidation or

the outsourcing of initiatives by smaller banks. There

could still be roadblocks, particularly political ones. But

if all goes according to plan, by 2011 the global payments

landscape could be a much more level place.

SEPA: One Continent, One Payment System

Source: “One Continent, One Payment System,” CFO Asia (April 2007), p. 41. (www.cfoasia.com) © 2007
by CFO Publishing Corporation.

Used by permission. All rights reserved.

Electronic funds

transfer (EFT) The

electronic movements

of information
between two

depository institutions

resulting in a value

(money) transfer.

Society for Worldwide

Interbank Financial

Telecommunication

(SWIFT) The major

international financial

telecommunications

network that transmits

international payment

instructions as well

as other financial

messages.

Clearing House

Interbank Payments

System (CHIPS) An

automated clearing

system used primarily

for international

payments. The British

counterpart is known

as CHAPS.

FUNO_C09.qxd 9/19/08 16:58 Page 232

Outsourcing

Subcontracting a

certain business

operation to an

outside firm – whether

abroad or at home –

instead of doing it

“in-house.”

9 Cash and Marketable Securities Management

233

••

l l l Costs and Benefits of Electronic Data Interchange

A host of benefits have been attributed to the application of electronic data interchange in

its various forms. For example, information and payments move faster and with greater

reliability. This benefit, in turn, leads to improved cash forecasting and cash management.

The company’s customers also benefit from faster and more reliable service. In addition, the

company is able to reduce mail, paper, and document storage costs.

These benefits, however, come with a cost. The movement of electronic data requires computer
hardware and software. The company must train personnel to utilize the EDI system.

In addition, time, money, and effort are often expended convincing suppliers and customers

to do business electronically with the company. Of course, the speed of an electronic funds

transfer eliminates float. For some corporations, the loss of the favorable float in disbursements is a
high price to pay.

Whether the benefits of adopting an electronic business document and payment system

outweigh the costs must be decided on a company-by-company basis. However, even for

those firms that embrace such an electronic system, it may be necessary (for legal, marketing,
and other reasons) to maintain a dual system – both electronic and paper-based – for some

time to come.

Outsourcing

In recent years, firms have increasingly focused on the core processes of their businesses –

those core competencies they possess to create and sustain a competitive advantage. All other

essential, but noncore areas of business are candidates for outsourcing.

Outsourcing – shifting an ordinarily “in-house” operation to an outside firm – is not a

“new” idea when it comes to cash management. Think back to our earlier discussion of lockboxes. Next
to a firm’s checking account, a lockbox service is the oldest corporate cash management service. The use
of a lockbox is but one example of the outsourcing of a critical but

noncore financial process. In fact, all the major areas of cash management – collections, disbursements,
and marketable-securities investment – are ripe for outsourcing consideration.

Outsourcing has the potential to reduce a company’s costs. The outsourcer (subcontractor) can use
economies of scale and their specialized expertise to perform an outsourced business operation. As a
result, the firm may get the service it needs at both a lower cost and a

higher quality than it could have provided by itself. In addition, outsourcing may free up time

and personnel so that the company can focus more on its core business. So, although cutting

costs is an important consideration in the outsourcing decision, it is not the only one. Indeed,

when The Outsourcing Institute (www.outsourcing.com) asked outsourcing end-users in a

2005 survey to list the reasons why they had outsourced, “reduce and control operating costs”

ranked first, “improve company focus” ranked a close second, and “free resources for other

purposes” came in third.

We have already seen outsourcing applied to collections (i.e., a lockbox system). The

growing interest shown by firms in electronic commerce makes the area of disbursements

especially well suited for outsourcing. Most likely, a bank would manage this outsourced

operation. For example, a firm might deliver a single file of all payment instructions to a bank

in EDI format. The bank would then separate the payments by type (check, ACH, or wire) and
make the payments. This service would be especially helpful to a firm needing to make international
payments. A major, money-center bank would have the technical expertise necessary

to handle the many currencies and clearing systems involved.

Business process outsourcing (BPO) is a more specialized form of outsourcing in which

an entire business process, such as finance and accounting, is handed over to a third-party service
provider. These outsourcing deals often involve multi-year contracts that can run into

hundreds of millions of dollars. Interestingly, while BPO companies are often located in

Business process

outsourcing (BPO)

A form of outsourcing

in which an entire

business process

is handed over to

a third-party service

provider.

Financial EDI (FEDI)

The movement of

financially related

electronic information

between a company

and its bank or

between banks.

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Part 4 Working Capital Management

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••
lower-cost countries such as India, Mexico, or China, many of these companies are actually

owned by multinationals such as IBM, Accenture, or Convergys.

Cash Balances to Maintain

Most business firms establish a target level of cash balances to maintain. They do not want

to maintain excess cash balances because interest can be earned when these funds are invested

in marketable securities. The greater the interest rate available on marketable securities, of

course, the greater the opportunity cost to maintaining idle cash balances. The optimal level

of cash should be the larger of (1) the transactions balances required when cash management

is efficient, or (2) the compensating balance requirements of commercial banks with which

the firm has deposit accounts.

Transactions balances are determined in keeping with considerations taken up earlier in

the chapter. Also, the higher the interest rate, the greater the opportunity cost of holding cash,

and the greater the corresponding desire to reduce the firm’s cash holdings, all other things

the same. A number of cash management models have been developed for determining an

optimal split between cash and marketable securities