Volk Fundamentals

7/29/2019 Volk Fundamentals

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Produced by CJVolk Associates, Inc.www.cjvolk.com

CASH MANAGEMENT PRIMER

An Introduction to the Fundamentals


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Preface

This booklet is intended to provide an introduction to basic concepts andthe tools of cash management. It should prepare you to discuss basicbanking services with your banks cash management officer. It should alsomake you aware of issues to be addressed in managing and controlling cashflow within your company or organization.

This booklet is not intended to provide a comprehensive discussion of allaspects of cash management. There are several excellent publications and

seminars providing the full scope of cash management knowledge, some ofwhich are listed in the Appendix. If you are or become responsible for cashmanagement, or simply wish to learn more about cash management, youshould find these resources valuable.


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Cash Management PrimerTable of Contents

PREFACE 2

WHATISCASHMANAGEMENT? 4

HOWDIDCASHMANAGEMENTDEVELOP? 5

WHATISTHEBASICCASHMANAGEMENTPROCESS? 6

CASHFLOWCYCLE 7

COMPONENTSOFFLOAT 8

HOWDOESMONEYMOVE? 9

PAYMENTSCLEARING 9

FEDWIRE 10

ACH 11

HOWARECASHMANAGEMENTSYSTEMSESTABLISHED? 12

CASHMANAGEMENTBANKACCOUNTSTRUCTURES 14

HOWISINFORMATIONABOUTMONEYMOVEMENTTRACKEDANDRECORDED? 15

WHYISBANKRELATIONSHIPMANAGEMENTIMPORTANT? 16

BANKFEES 17

HOWDOYOUINVESTSURPLUSCASH? 18

INVESTMENTPOLICY 18

MONEYMARKETINSTRUMENTS 18

HOWARECASHSHORTAGESMANAGED? 19

DOESINTERNATIONALCASHMANAGEMENTDIFFERSIGNFICANTLYFROMTHE US? 20

WHATRESOURCESAREAVAILABLETOLEARNMOREABOUTCASHMANAGEMENT? 20

APPENDIX 22


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What is Cash Management?

Cash management is the movement of fundsthrough financial institutions to optimize liquidity.It is the management of corporate funds toincrease interest income earned by maximizinginvestments and/or reducing interest paid byminimizing borrowings.

Cash management uses the knowledge of fundsmovement through the banking system, coupledwith banking services and other financial products,to optimize liquidity. It is the scheduled gatheringof information about a companys cash flow, itsreceipts, disbursements, and balances. This

information is used to manage these elements ofworking capital.

Effective cash management ensures the timelyprovision of cash resources necessary to supportthe companys operations. With the use of basiccash management tools and techniques, cashbecomes a corporate asset that contributes directlyto the bottom line. Whether a company is flushwith cash or experiencing a shortfall of funds,good cash management is critical to the success ofevery company.

Cash management is a financial discipline that usesthe same principles, regardless of the type of

business, size or age of an enterprise. Cashmanagement is not an accounting function. Theaccountant records and reports transactionshistorically; the cash manager plans and executesthese financial transactions. Cash managers usetechniques, products and services to efficientlymanage cash resources and satisfactorily resolvecash shortages or surpluses.

The major elements of cash management are:

Deposits: Receiving funds and depositingreceipts into the bank account as quickly aspossible, while collecting adequate informationto correctly identify the source of the payment.

Concentration: Moving funds to a centrallocation from which they are more efficientlymanaged for investing and disbursing.

Disbursement: Paying funds by check orelectronically to vendors, employees,investors, and others.

Information gathering, analysis and control:Reporting funds information, including:current cash position, forecasted shortages and

surpluses, cost-benefit of proposed changes incash management operations or outsourcedservices, interest rate or foreign currency riskexposure, and many other monetarycircumstances which affect corporateresources.

A cash managers duties typically include:

Monitoring the daily cash position. On a dailybasis, the cash manager typically spends thefirst part of the day developing the cashposition. This exercise identifies shortagesand surpluses in time to either borrow funds

to cover the shortfall or invest excess funds.The cash manager first confirms the priordays closing balance, typically using on-lineor Internet bank reporting. Forecasted andscheduled disbursements, receipts, loanrepayments, and maturing investmentproceeds are then added and subtracted tocalculate the days cash flow. The cashmanager also typically administers the creditfacility borrowing on a day-to-day basis. Thisdaily reconciliation process also provides aneffective method of immediately revealingunauthorized or fraudulent transactions.

Controlling balances on deposit. The cash

manager maintains bank balances at a leveladequate to avoid overdrafts and tocompensate the bank for cash managementservices. Short-term borrowing may benecessary to meet the required balances.Excess funds are typically invested, short-orlong-term, until they are required to covercapital or operating expenditures.

Moving funds as necessary. The cash

manager may control several different bankaccounts, perhaps in different states or evenforeign countries. The transfer of monies fromone account to another is often a daily exerciseto prevent cash shortages in the accounts andto promptly invest surpluses.

Managing short-term (working capital)borrowing and investing. Whether a companyis an overall investor or borrower, theunsynchronized timing of operating cash flowsrequires the cash manager to be both aborrower and an investor. On any given day,the cash manager may borrow to meet short-term cash requirements or invest surplus cash.


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Forecasting future shortages andsurpluses. To determine the amount andvarious maturities of the investmentportfolio, the cash manager must predictfuture cash flows. Investing for a shorterperiod than necessary usually results in lostearnings; and investing for too long maycause premature security sales at a loss iffunds are needed before maturity.Forecasting also allows the cash manager toplan for an adequate level of short-termcredit facilities.

Managing banking relationships. The cashmanager maintains a mutually beneficialrelationship with the company's bankers. If

the cash manager develops an open andstraightforward relationship, the banker candevelop a good understanding of thecompanys operations and can bring relevantbanking products and services to theattention of the cash manager.

Performing analytic reviews and feasibilitystudies of banking services. The cashmanager is the employee with primaryresponsibility for evaluating the benefits anddrawbacks to adding new or terminatingexisting banking services. A company selectsa bank that offers reliable, cost-effectiveservices. The cash manager is responsible

for monitoring the banks services and feesto ensure that the arrangement remainssatisfactory and that pricing is contractuallyaccurate.

Analyzing, designing and implementingcash management systems and procedures.Through the day-to-day tasks involved intheir job, cash managers know systemrequirements to carry out cash managementefficiently. Cash managers have aprofessional responsibility to keep up-to-dateon developments in cash managementproducts and practices by attendingconferences, reading journals, and other

networking and continuous learningactivities. While growing professionally, thecash manager acquires and updates the skillsand knowledge necessary to implement thecash management systems and proceduresbest suited to the company objectives.

How did Cash Management

develop?

Cash management in the U.S. has been shaped bythe structure of the domestic banking system, theU.S. Postal Service, and the prevalent use of checksfor payment. The U.S. is unique in its large numberof banks with limited national branch banking andits convention of bill payment primarily by checkthrough the U.S. mail. Legislative and regulatoryinfluences have also played a major role in thedevelopment of current cash managementpractices and continue to do so today.

Modern cash management can be traced back to1947, when the Radio Corporation of America(RCA) set up a lockbox collection system fordealers to deposit payments to RCA for loans tofinance inventory. Payments were mailed to aspecial post office box set up exclusively for thesepayments. The bank collected the mail directlyfrom the post office box and deposited the checksdirectly into RCAs bank account.

Cash management responded to rising interestrates in the 1960s and 70s by becomingincreasingly sophisticated. Corporationsrecognized cash as an asset able to generateincome and saw that there could be a monetaryreturn for actively managing cash. Many of thebanking products used by cash managers todaywere developed during this period of runawayinflation: controlled disbursement, fundsconcentration, real-time transaction reporting, andelectronic payments.

Later, financial markets erupted with innovativeinstruments and products. The introduction ofNegotiable Certificates of Deposit (CD) was theresult of banks managing their assets andliabilities more aggressively. A secondary marketfor trading these instruments quickly developed ascorporate treasurers realized they could investotherwise idle bank deposits in these relativelyrisk-free instruments and, if necessary, haveaccess to the funds before maturity. Cashmanagers were offered many new investmentoptions, including bankers acceptances,repurchase agreements, and commercial paper.

The explosion of desktop computing in the 1970sand 80s, coupled with corporate computerapplications development, made a major impacton cash management. Cash managers could noweasily concentrate bank balances into a central


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account by electronic funds transfer, retrieveinformation automatically from banks on a

timely basis, and perform transactions in realtime and on-line. The electronic spreadsheetstreamlined the generation of cash positionreports and analytical tasks such as cashforecasting, which provided management criticalinformation for strategic planning.

In the 1990s, the financial environment turnedits focus to risk management: bankcreditworthiness, payments system risks, anduse of derivatives to hedge against financial risksmore precisely. Security concerns generated aflurry of legislative and regulatory activity.

At the beginning of the 21st century, cash

management has developed a global emphasis, asthe worlds capital markets become more closelyaligned and local economies have become sobroadly international. Technology, including theInternet, is now used extensively in cashmanagement in most enterprises. Technologicalenhancements have led corporate management toexpect even more from their treasurydepartments. The efforts toward benchmarking,re-engineering, and outsourcing that began in thelate 1990s continues to gain momentum.

What is the BasicCash Management Process?

Every successful company has a pool of cash thatsustains the day-to-day activities of business. Itgrows with receipts from sales and contributionsand shrinks with expenditures for inventory,marketing, labor and other expenses. Theuncertainty of cash inflows and outflows createsthe challenge of ensuring that sufficient fundsare available at all times to support the operatingcycle. Cash flows of both types must be closely

managed. There are a variety of cashmanagement tools and techniques to assist inthis process, which will be discussed later.

Borrowing becomes necessary when cash flowfalls short of covering disbursements. Whenincoming funds exceed the outflow, cash is usedto repay borrowings or purchase short-terminvestments until the cash is needed to coverfuture expenses.

Financial officers need timely information toproperly control and use their funds throughout

the cash flow cycle. The Basic Cash ManagementProcess provides that timely information. Thecash flow timeline includes the total time intervalbeginning with the first phase of the operatingcycle, when resources are purchased, until the laststep when receipts are collected. It consists of thefollowing steps:

1. Material purchases. Acquisition of rawmaterials or merchandise for resale includesnegotiation of the method of payment, creditterms and trade and payment discounts.

2. Payment for resources. All resourcesrequired to support sales, including labor,

marketing and overhead expenses, incurfinancing costs until cash is collected for salesmade. By managing the timing ofdisbursements, the cash manager canminimize implicit financing expenses.

3. Sale of inventory or services. Merchandiseand other sales are most frequentlyaccomplished by extending credit tocustomers. The timing of accounts receivablecollection is a major focus in cashmanagement.

4. Collection of receipts. Only when thecustomer has provided good funds for the

merchandise or service does the cash flowcycle conclude for that transaction.

The cash flow and operating cycles are similar.The cash manager focuses on the timing of thecash flows related to accounts payable, accountsreceivable and inventory turnover. Operationsmanagers concentrate on the timely availability ofmaterials and resources and on sales volumes,relying on the cash manager to ensure adequateliquidity to support operations. Cash forecasting isbased on understanding both the Operating andthe Cash Flow cycles.


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Float: The most critical component inCash Management

Float is the time interval between the start andcompletion of each step in the cash managementcycle. The management of float is themanagement of cash. Each cash managementsystem is designed to improve the flow of cashby accelerating the collection of funds andextending the disbursement float. There are twocategories of Float: Collection Float andDisbursement Float, each with severalcomponents.

Collection Float is the time spent to collectreceivables. Collection float is the sum total oftime taken by the following four components:

1. Invoicing floatis the time period between thedelivery of goods or services to the customer

and the customers receipt of the bill,generally by mail. It is the time it takes acompany to record its delivery of service orgoods and then to produce and mail a bill.Typically, the cash manager has little controlover this function, although it is generallythe Collection Float component with thelongest duration. Cash managers havefocused almost exclusively on the remainingthree components.

2. Mail float is the time it takes the U.S. PostalService to deliver the customers payment.

3. Processing float is the period between thereceipt of the payment and its deposit into thecompanys bank account and includes the time

it takes to record the payment in theaccounting system.

4. Availability float is the time it takes thedeposited check to clear the customersaccount and for good funds to be available tothe company for disbursement.

As early as 1947, RCA set up a lockbox collectionarrangement to accelerate the receipt andprocessing of payments. The objective was toshorten the float for mail, processing, andavailability. Current lockbox services andproducts still concentrate on these areas.

Disbursement Float is the time it takes acompanys payment to be created, mailed,received, deposited and presented to the draweebank for settlement. Thus collection float anddisbursement float refer to the same processesand time intervals depending on point of view:For the company receiving a payment, collectionfloat represents the time it takes an invoice to beprepared, to reach the customer, to receivepayment and for the payment to clear the bank.

Operating Cycle

Cash Flow

Timeline

3. Sale of

Inventory

2. Convert Material to

Goods for Sale

4. Collection of

sales receipts

1. Material

Purchases

2. Payment for

resources

3. Sale of

Inventory

4. Collection of

sales receipts

1. Material

Purchases

Cash flow versus business operations cycles


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For the company making the payment, that sameinterval is disbursement float.

Disbursement float consists of the following fourcomponents:

1. Invoicing and payment processing floatincludes both the time it takes the supplierto prepare and send the invoice, as well asthe time the accounts payable departmentrequires to process the invoice and create thepayment.

2. Mail float is the time it takes the U.S. PostalService to deliver the payment to the vendor.

3. Processing float is the time it takes thevendor to record the payment and deposit it

into the bank.

4. Availability floatis the time it takes the bankto clear the check and deduct the funds fromthe payees bank balance.

Cash management focuses on shorteningcollection float and extending disbursement float,

tempered by maintaining positive customer andvendor relationships.

The skillful management of float contributes realbottom-line impact and benefit to the company.This financial result is measured by a simplemathematical formula:

[Float dollars] x [time] x [interest rate earned orpaid] = monetary benefit.

AccountsPayable Float

Purchase & Pay

PurchaseMade

InvoiceReceived

PaymentMailed

PaymentReceived

CheckDeposited

FundsDebited

Sell & Collect

MakeSale

PaymentSent

PaymentReceived

FundsAvailable

Payment Float

Disbursement Float

Accounts Receivable Float

SendInvoice

CheckDeposited

Collection Float

Components of Float

Invoice Float

InvoiceReceived


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How does money move?

Money moves in three ways: (1) exchange ofcurrency, (2) presentation of a paper item or (3)electronic transaction. Cash may be common forsmall purchases of goods and services, butchecks and electronic transfers are used almostexclusively in most business environments. Inspite of the growth of electronic payments, paperchecks account for the majority of businesstransactions. Electronic payments, while muchlower in total transaction volume, aresignificantly higher in dollar value with theexception of direct deposit payroll.

Cash managers monitor and often initiate both

electronic and paper transactions through theuse of cash management services provided bybanks. Effective use of these services results inbetter control and use of corporate funds.Several types of services are discussed later.

Paper Transactions

Paper transactions consist of checks or draftsthat transfer value from the payor to the payee.Each bank accepting checks for deposit(depository bank) must, in turn, collect fundsfrom the bank that holds the check makers

deposits (drawee bank). This is accomplished byphysically presenting the check for payment.

Pilot studies have been conducted in checktruncation. The process electronically capturesdata from the checks MICR line (which containsbank transit routing number, account number anddollar amount) and sends the information to thedrawee bank for same day settlement of funds.The physical checks are either destroyed ordelivered to the drawee bank via a more leisurelyroute. Despite the pilot efforts, the U.S. bankingsystem still requires physical check presentmentfor funds settlement. Paper items are collected inmany ways, but most commonly in one of thefollowing three: (1) through the Federal ReserveSystem, (2) through the Local Clearinghouse, or (3)by directly sending checks to CorrespondentBanks. Checks deposited into the same bank onwhich they are drawn, referred to as on-us, arecleared within the bank with simultaneous debitsand credits to the payor and payees accounts.

Checks may be presented to any of the FederalReserve processing centers for clearing to anyother U.S. financial institution. The FederalReserve, in turn, transports and presents thechecks to the drawee financial institution. Tocollect through the Federal Reserve network, thedepository bank delivers a cash letter to one of theFederal Reserves 48 check processing centers. A

cash letter is a batch ofchecks accompanied byadding machine tapes and asummary document thatincludes the total dollardeposit. Banks may delivercash letters directly toseveral different FederalR e s e r v e g e o g r a p h i clocations in order toexpedite the settlement offunds.

L o c a l C l e a r i n g h o u s eA s s o c i a t i o n s e x i s t

throughout the U.S. for thepurpose of exchangingchecks drawn on localmember banks. Eachmember bundles checks forexchange and delivers thesebundles to other membersat designated t imesthroughout the day. At thelast exchange of the day, net

Local Clearinghouse

Direct send to Correspondent

Paper Transactions

Payors Check US Postal Service Payee Company

Payors Bank

Regional Fed Local Fed

Payees Bank


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settlement amounts are computed and paymentsare made through the Fed accounts of each

member bank.

Delivering a cash letter directly to aCorrespondent bank outside the local area iscommonly referred to as direct sending. Thecash letter may contain items drawn solely onthe receiving Correspondent bank. It may alsoinclude items the Correspondent bank will clearas agent for the sending bank.

Cash management banks focus significant efforton improving the speed with which they are ableto clear their customers deposits and typicallyuse all of the above three methods to collectfunds. Each method yields different availability

schedules and has related costs. To achieveaggressive availability, the cash manager must beprepared to sometimes pay a premium forbanking services.

Electronic Transactions

Electronic transactions do not rely on paper tomove money. There are two types of electronictransfers in the U.S. banking system: (1) wiretransfers using the Federal Reserves Fed wiresystem and (2) Automated Clearing House (ACH)items. Both methods are referred to as electronicfunds transfer (EFT) transactions. EFT is the

transmission of an electronic message to adepository financial institution requesting thatfunds be transferred from one depositoryaccount to another account.

International transactions between major U.S. andforeign banks typically use the Clearing House

Interbank Payments Company (CHIPS) forelectronic, end-of-day settlement of funds. TheSociety for Worldwide Interbank FinancialTelecommunications (SWIFT) is a network thatcarries instructions to move moneyinternationally, but does not directly settle funds.Instead, each member is responsible for arrangingfunds transfers, generally through theircorrespondent banks.

Fed wire transfers settle through the FederalReserve Bank. These are real-time transactionsin which the Federal Reserve accounts of thepayee and payor financial institutions aresimultaneously settled. Immediately uponreceiving instructions from the payorinstitution, the Fed reduces the payorsaccount and increases the payee account by alike amount. Once the Federal Reserve Bankbooks the debit and credit entry that transfersvalue, the transaction is irrevocable. Eachcompleted transfer is assigned a Fed wirenumber by which the payment can be traced tothe payees account and confirmed. Wiretransfers are the most expensive method ofpayment. For that reason, they are typicallyonly used when a company requires animmediate and final settlement of funds, suchas in a purchase of real estate.

Sending

Banks FedWire Room

Electronic

Messageto Fed

Federal Reserve

A B

Electronic

Notification ofDeposit

Receiving

Banks FedWire Room$

Fed Wire

A - Sending Banks Fed AccountB Receiving Banks Fed Account


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Automated Clearing House (ACH)transactions operate according to rules andguidelines promulgated by the not-for-profitNational Automated Clearing HouseAssociation (NACHA). ACH transactions aremost widely known as the means by whichdirect deposit payroll is settled. ACHpayments may, however, be set up to eitherdebit or credit the originating companys

account. For this reason, the terms payeeand payor are not used in describing ACHtransactions. The parties instead arereferred to as the originator or therecipient and a transaction is described aseither an ACH credit or an ACH debit.ACH credit transactions move funds from theoriginators account to the receivers accountwhile ACH debit transactions move fundsfrom the receivers account to theoriginators account. For example, with adirect deposit payroll transaction, theoriginator is the employer, the recipientis the employee and the transaction type isan ACH credit. In the instance of a utilitycompany collecting payments on a monthlybasis from its customers, the utility companyis again the originator, the customer is therecipient but the transaction type is anACH debit. A company may initiate a singleACH transaction, but typically the ACHprocess is used as a batch process permittingthousands of ACH transactions to occur atthe same time at a low cost per transaction.

As a batch process, ACH transactions do notsettle immediately and simultaneously as Fedwire transfers do. ACH credit transfers forpayroll direct deposit, for example, must beoriginated at least two business days prior tothe settlement (value) date. Under NACHAguidelines, there are specified circumstancesthat permit the return of the ACH debits andcredits. Unlike Fed wire transactions,payments made through the ACH network areneither immediately settled nor irrevocable.

OriginatingCompany

OriginatingBank

LocalACH

NationalACH

(NACHA)

Credit orDebit to

ReceiversBank

Account

ReceivingBank

ACH Funds Movement


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How are Cash Management

Systems established?

For funds management to be as efficient aspossible, the flow of funds must beaccomplished as passively as possible. Inestablishing the corporate bank accountconfiguration, the focus should facilitate theautomated movement of funds.

Separate accounts are established for differentbusiness functions: payroll, retail outletsdepository accounts, accounts payabledisbursements, and lockbox receipts. By

maintaining separate accounts, accountreconciliation to the general ledger balance isaccomplished more easily and in some cases, canbecome an automated daily process. Fraudulentactivity and unauthorized transactions are morereadily apparent and detected with less effort,improving overall audit trails and internalcontrol.

The master (or concentration) account is thecentral point through which all corporate fundsmove and from which corporate liquidity iscentrally managed. After the initial deposit ofreceipts, funds should automatically move into

the master account. Moving available balances toa single account eliminates small, idle balances.From a master account, funds can be used to paydown debt, cover payments, and invest. Withoutthe use of a central master account, determiningdaily cash requirements and forecasting theshort term cash position would be significantlymore complex. Mobilizing the funds needed tocover daily cash movements would requirenumerous transfers and intensive human effortto keep the funds flowing as needed day in andday out.

Collection and concentration services are

offered to convert a companys receipts andreceivables into available operating capital, thatis, cash on hand. These services are designed tominimize certain components of float andconcentration funds into one main, or master,account. From the master account, the cashmanager can determine cash on hand to coverthe daily clearing of checks, scheduled debtservice or dividend payments and short-terminvestments.

To process and deposit payments received bymail, a lockbox service can be contracted with abank or third party vendor. A lockbox serviceprocesses payments received through the mail.Customers are instructed to mail their payments toa special post office box address. The bankarranges to pick up the mail several times a dayand take it immediately to the area where thepayments are processed and the checks deposited.Customer account numbers and payment amountinformation is forwarded to the company toupdate its accounts receivable system. Becausepayments are received directly by the bank, thedeposit and collection of funds are expedited.There are two basic types of lockboxes: wholesaleand retail.

Wholesale lockboxes process a relatively smallvolume of large dollar payments that are typicallyaccompanied by numerous and varied paymentdocuments, such as the payors purchasingdocuments, a listing of multiple invoices beingpaid or detail information referencing contractnumbers and voucher data. A copy of the check ismade and matched with the documents receivedwith the payment. Payments are endorsed,batched and deposited by the banks lockbox area.The primary advantage of a wholesale lockbox isthe acceleration of the collection of funds forthese large dollar checks. The company does the

update of the customers accounts from the checkcopy and documents delivered to the company bythe bank. It is a manual process.

Retail lockbox services handle a high volume ofpayments, generally of a small dollar amount.Examples of payments processed in a retaillockbox environment include utility payments,gasoline credit card payments, magazinesubscriptions and consumer loan payments. Retaillockbox processing relies on high-speedequipment to electronically read the check andcustomer account information. Customers makingpayments through a retail lockbox are provided

with a remittance document or paymentcoupon, which they are asked to return with theirpayment. This remittance document containsaccount information usually in some sort ofscannable format, such as a bar code, from whichthe bank is able to capture informationelectronically. Generally the company requeststhe payment and account information be receivedfrom the bank as an electronic file for uploaddirectly into its receivable system.


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A companys specific lockbox arrangements canbe customized by contractual arrangement.

These lockboxes may be referred to as customretail, wholetail or a similar designation.There are also electronic lockbox services beingdeveloped for the receipt of ACH, credit card andother non-paper payments.

Deposit consolidation or Cash concentrationbecomes more challenging when there areseveral retail establishments, corporate divisionsor branches that span a wide geographic area.

Retail and branch depository services typicallyconsist of numerous bank accounts spread over

several states, or even worldwide in order to beconveniently located for prompt deposit ofreceipts. Security and employee safety may alsobe considered in selecting a local bank, althoughthese factors are mitigated if an armored courierservice is used to pick up deposits at the sites.For the cash manager, however, the focusremains on concentrating the funds fromaccounts throughout this network of retaildepository banks quickly and efficiently.

Non-retail corporations or organizations mayalso have depository accounts throughout thecountry. It is not uncommon for corporate

divisions and branches to accept paymentsdirectly and track their collections anddisbursements independently. The cashmanager may be required to separately identifyeach divisions cash flow for reporting,forecasting and control purposes. To optimizecash liquidity and to use working capital mostefficiently, these various sources of funds mustbe moved into the master concentration accountand managed on a corporate level. Imagine eachdivision or store managing its own pool of funds.Without the benefit of centrally managed cash,each entity would be required to borrow orinvest as its individual needs dictated,irrespective of the overall corporate cashposition. Centralized cash management cantrack the cash position of each unit, providinginter-company loans to support operations,capital improvements and expansions andinvesting pooled surplus funds at a higher rate ofreturn. Borrowing done on a corporate-widebasis is typically more favorably priced andeasily available. If the corporation elects to issuecommercial paper or corporate bonds, it isessential to manage these programs centrally.

The movement of funds from a division or storesaccount to the concentration account can be

accomplished in several ways. If division depositsare made into a branch of the concentrationaccount bank, divisions may be provided withdeposit slips directing the money into theconcentration account. A zero balance account(ZBA) or similar arrangement can be establishedwhich results in account balances being moved tothe concentration account at close of businesseach banking day. If the depository bank is not thesame bank that holds the concentration account,funds are transferred one of three ways: (1) papercheck (2) ACH or (3) Fed wire.

A paper check, known as a Depository TransferCheck (DTC), is created and deposited into theconcentration account. A typical corporate systemmay designate an internal clerk or contract with athird party administrator to accept a daily phonecall or an electronic report from each division orretail outlet reporting the days deposits. Thecorporation then creates a DTC for eachdepository account and deposits it into theconcentration account. A third partyadministrator may also collect the divisionsreports and create a file to transmit to theconcentration bank. The file includes the relevantdeposit account information and amount for eachsite and requests that a DTC be created for depositto the concentration account. This method may

also be used to request ACH transfers.

ACH transactions are the least costly method ofmoving funds. ACH transfers may be initiated viaan on-line banking system or by direct filetransmission. One possible scenario would berequesting daily electronic reports of depositamount from each division, either by e-mail orentered directly into a database. This data wouldthen be forwarded to the bank for processing as abatch ACH file. As ACHs may be either debits orcredits, it is also possible for each division toinitiate an individual ACH credit moving the fundsfrom the local to the concentration account.

Wire transfers are the most costly method ofmoving money. A wire transfer would nottypically be used as a daily cash concentrationmechanism. However, for very large deposits, awire transfer ensures same day settlement offunds into the concentration account. Only fundsthat are immediately available (that is, zero float)may be transferred by Fed wire.

Disbursement Accounts are established to enable


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a company to know what has been paid and whencash is needed to cover those payments. As

discussed below, separate disbursementaccounts also improve control and protection offunds and expedite reconciliation.

Disbursement systems typically consist of atleast one account for vendor payments and onefor payroll. If the corporation has more than onedivision, it may wish to track expenditures andpayroll separately for each entity. This may beaccomplished by (1) opening additional bankaccounts or (2) structuring a multi-tiered (sub-account) system. Multi-tiered arrangementspermit (a) centralized management by using oneparent disbursement account for funding allpayments, (b) division by division tracking by

using a subsidiary account of the parent for eachdivision, and (c) reduced banking fees.

Disbursement services developed, in part, as anattempt to extend clearing float. The Fed has,however, significantly reduced this float over theyears. As a result, disbursement accounts todayare designed primarily to assist a company incontrolling, funding and reconciling payments.

Zero Balance Accounts (ZBA) are designed tomove all excess balances from depository accountsinto a single master or cash concentration accountand to fund all disbursements accounts from themaster account. Transfers are made automatically,

with all individual accounts maintaining a constant

$

$

$

Concentration andDepository Account

Overnight Investment

Payroll

Accounts Payable

Lockbox 1Depository

Account

Lockbox 2Depository

Account

Lockbox 3Depository

Account

RetailDepository

DelinquentCollectionsDepository

$Concentration

Account

PayrollSalary

PayrollHourly

AccountsPayable

HealthInsurance

Claims

PettyCash

OvernightInvestment Sweep

Account

Example of a Complex Company Structure

Example of a Simple Company Structure


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zero balance. During the day, deposits anddisbursements are made to and from the

individual zero balance accounts. This tracks thefunds by division, function or other structure asdefined by the company in setting up theaccounts. At the end of the banking day,transfers are made to move funds into and out ofthe master account in the amounts necessary tocreate a zero balance in each individual accountlinked to the master account.

The use of a ZBA account structure lets acompany track individual subsidiary operationswhile allowing those subsidiaries to functionindependently. This system allows centralizedcontrol of available cash on a daily basis.

Controlled Disbursement Accounts provideeven greater control and knowledge of the dailycash flow. Controlled disbursement permits acompany to know on a current day basis howmuch funding will be required to cover paymentspresented for settlement. The total dollar valueis available early in the day, allowing thecompany the necessary time to invest orliquidate funds or to borrow money on a sameday basis to cover cash shortfalls. Controlleddisbursement accounts are structured to receivepresentment of checks to be paid (via the cashletter) on a current day basis only from theFederal Reserve Bank. No checks on theseaccounts are accepted through localclearinghouses or as direct sends. Funding isimmediate, usually via Fed wire, which keeps thecontrolled disbursement account balance at zero.

In addition to the special disbursing accountsdescribed above, most cash management banksoffer additional services to reconcile theseaccounts, enhanced methods to protect againstfraud and complete disbursement outsourcingsolutions.

Partial and Full Reconciliation Services providereports of sequentially numbered paid items ineither a paper or electronic format. With PartialReconciliation, the company compares the list ofchecks paid with the list of the checks it issuedto produce a list of outstanding checks. FullReconciliation services involve the companyproviding a file of all issued checks to the bank.The bank matches the checks paid against thechecks issued and generates an outstanding

check file for the company.

Positive Pay is a cash management service toassist in detecting and preventing check fraud.With this arrangement, the company provides thebank with timely and complete files of all issuedchecks. The bank compares the items presentedfor payment against the check issued file. If theitem does not match the amount or a checknumber on the issue file, it is flagged as asuspicious item and the company is immediatelynotified. The bank will ask the company to make apay or no pay decision on the item. Themajority of suspicious items result from a delayin notifying the bank about issued items; however,counterfeit, stolen check stock and altered checkswill all be detected in this process, and significantlosses can be averted.

Accounts Payable Outsourcing simply shifts thetask of issuing payments to the bank. A file ofpayments to be made is extracted from theaccounts payable system and sent to the bank or athird party vendor. The file may designate if thevendor is to be paid by check or electronically.The bank initiates payment according to theinformation provided on the file.

How is information aboutmoney movementtracked and recorded?

Once a company has established the bank accountstructure and cash management services itdetermines are appropriate for its operations, itneeds a method of monitoring and forecasting itsdaily cash flows. Maintaining the necessaryliquidity on a daily basis requires forecasting,tracking, borrowing and investing activities.Typically, a daily target balance is selected andfunds are managed to that goal. Meeting the target

balance depends on accurate and timelyinformation about day-to-day receipts anddisbursements plus any banking requirements fora compensating balance. Managing to that goalrequires skillful cash forecasting, the availabilityof a borrowing facility and/or attractive short-terminvestment opportunities.

Information Reporting Systems are the


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principal and initial source of cash managementinformation. As noted in the discussion on theaccount structure, the concentration, or master,bank account serves as the companysclearinghouse and control point for all cash flow.On a daily basis, the cash management bankprovides a balance report. This report includesnot only the ending balances for the priorbusiness day, but an analysis of that balancewith respect to its deposit float, or theuncollected, and thus unavailable, portion of thefunds. Also provided are all transactions for theprior day, including wire transfer details, depositconsolidation, investment purchases andmaturities and all other activity moving throughthe concentration account.

This report is typically retrieved on-line using apersonal computer and proprietary bankingsoftware requiring various security layers ofpassword protection, depending on the nature ofthe system access. Comparing the prior daysactivity reported by the bank to the companysrecord of transactions and forecasted activityestablishes a substantial control procedure.Daily reconciliation immediately identifiesunauthorized electronic transfers, posting errorsand other irregular activity. Coupled withpositive pay services for the protection ofpayments made by check, the daily reconciliationprocess is the most effective means of

identifying fraudulent activity. 1

In addition to retrieving the prior day activityand closing balances, major cash managementbanks provide on-line, intra-day transactionreporting. These reports include current daylockbox deposits, incoming and outgoing wires,controlled disbursement cash letter amounts andprovisional credit for ACH transactionsscheduled to settle at the close of business.

Designing an organized and efficient method ofusing this information daily is a major challenge

facing all cash managers. Information must beretrieved, summarized, tracked and analyzed.Forecasting short-term cash flows of receipts anddisbursements is an essential cash managementfunction. Tracking the forecasted cashtransactions to the actual is a daily task tovalidate the accuracy of the forecast.

In order to complete these daily tasks on a timely

basis, cash managers frequently developspreadsheet applications. If the manager isdealing with many banks and a large number ofbank accounts, spreadsheet solutions may not beadequate. Treasury Workstations (TWS),sometimes called Treasury InformationManagement Systems (TIMS) are software modulesthat automate many of the cash managersinformation collection, monitoring and analysistasks. These systems may be purchased fromsoftware vendors for prices varying widely andsometimes moving well into the six-figure range.Banks have previously developed TWS softwareproducts for their customers, but in recent yearsmost have discontinued this service. Companies

with sophisticated information technology (IT)resources may develop proprietary software.Because TWS are database programs, they arefrequently interfaced with the companys generalledger for automation of treasury journal entryposting.

The banking systems developed for informationreporting also permit certain transactions to becompleted on-line. Wire transfers, direct depositpayroll transmissions, stop payment orders andforeign currency purchases are examples of thetypes of on-line services most cash managementbanks provide.

Why isBank Relationship Management

Important?

A companys relationship with its banks is muchmore complex than the typical vendorrelationship. Banks are the source of workingcapital, custodian of a companys liquid assets,and a critical reference polled by major suppliersand credit rating agencies, such as Dun &

Bradstreet. The services available to a companyand the costs of those services depend on afavorable assessment by the bank of thecompanys financial stability.

In turn, the banks financial position must bemonitored by the company to avoid the disastrous

1 Under the current Uniform Commercial Code, a company may be questioned as to its daily reconciliation procedures to determine if there iscontributory negligence in the event of a loss.


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consequences following a bank failure. To alesser degree, changes in bank management, or

exiting certain markets, such as credit cardprocessing, can also create hardships forcompanies caught off guard.

A productive and beneficial banking relationshipis based on good communication, mutual trustand respect and confidence in the stability andfinancial health of each party. Open andfrequent communication is the keystone forbuilding the relationship. Banks dislike surprisesof any sort; surprises undermine the companyscredibility and cause concern about thecompanys candidness. Large companiesgenerally hold regular meetings for its bankers,providing financial statements, discussingupcoming plans, such as acquisitions ordownsizing, and identifying future bankingservices and financing needed to support theplans.

Initially the company should apprise the banksof its cash management practices, bank accountstructure and expectations regarding the banksperformance. On an on-going basis, thecompany should immediately address anyoperating problems or banking errors. Amechanism, such as bank report cards, may beused to provide timely feedback about thequality of banking services.

It is important to recognize that the bank isentitled to fair compensation for servicesrendered. A relationship based on constantpressure to reduce or eliminate fees is not a goodone and is likely to terminate at an inopportunemoment. Banking fees have been subject to thepressure of competition over the past severalyears. As a result, many banks have merged orexited cash management and other corporateservice markets.

The cash manager must consider the availability,quality and costs of banking services indeveloping an appropriate banking strategy forthe company. A crucial decision is whether tospread business among several financialinstitutions or to concentrate business in onebank. Concentrating all business in one bank

may result in better pricing, if the business is of a

significant size for the bank. The company mayalso enjoy more attention and support from thebank than its smaller customers do. However, bydealing with only one bank, the company may riskhardship in the event of a bank merger or a majorshift in the banks market focus.

Bank Fees

As noted, fair compensation for services providedis an important factor in the banking relationship.Banks are compensated in three ways: (1) intereston credit services, (2) fees and (3) compensatingbank balances.2 A company may use all three as a

means of paying for services received.

The cash management bank produces an accountanalysis statement monthly. This statement isessentially an invoice describing the types andvolume of transactions for the period, the fees forthose services and an earnings analysis for theaverage deposit balance in the account. Theimputed income from the deposits (less theuncollected funds and a 10% reserve requirement)is deducted from the fees charged to determinethe amount, if any, owed to the bank for servicesreceived that month.

A cash manager will evaluate multiple factors inselecting the method of compensation. He or shewill weigh the opportunity cost of leaving fundson deposit to cover banking fees. There may berelationship considerations that favorcompensating balances, such as more favorablecredit terms. Use of compensating balanceseliminates banking fees from the incomestatement.

2 Under banking Regulation Q, interest cannot be paid on corporate demand deposit accounts; however, this Regulation is under review forrepeal.


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How is surplus cash invested?

Surplus cash can arise from many sources: thesale of stock, loan proceeds, seasonal salespeaks, growth of earnings and simply theacceleration of the cash flow cycle. If thecompany has outstanding debt, especially ashort-term working capital credit facility, themanager may elect to pay down the liability. If,however, the cash surplus is temporary, the cashmanager may want to invest in short-term,money market instruments.

There are three areas that need to be defined in

any investment strategy and should be clearlyspelled out in all investment policies: (1) risktolerance (protection of principal), (2) liquidityand (3) return. These factors are listed in order ofpriority. The preservation of principal is aserious consideration in the selection of aninvestment. Although there is some degree ofrisk in all investments, that risk is identifiableand may be controlled. The capable manager willchoose investments that offer both income andthe safety of principal.

Cash managements primary objective in holdingshort-term investments is to maintain adequate

liquidity: assurance that investments can beeasily sold prior to maturity to cover unexpectedcash shortfalls. The investment strategy forshort-term holdings is to maintain an adequateliquidity reserve (or cushion) while increasinginterest income.

Investment Policy

Most companies recognize the importance ofestablishing an investment policy. The policyspells out who has investment authority and howthat authority is to be carried out and monitored.The policy typically specifies:

The types and quality of investmentspermitted

The qualifications and standards for dealersand issuers from which investments arepurchased

The maturity and diversification guidelines

The custodian requirements for holdingsecurities and

The method of performance measurement orbenchmark guidelines

Money Market Instruments

Short-term securities vary widely in credit quality,negotiability, yield and maturity. The market fordebt and equity instruments consists of (1) theshort-term money market in which short-termfixed income and debt securities are traded and (2)the longer-term capital market. Cash managementfocuses on the former the money market.

The money market is a group of markets selling

debt instruments that mature in one year or less.Money market securities include:

U.S. Treasury securities are issued by the U.S.government to finance its activities and areconsidered relatively risk-free. The secondarymarket is enormous and thus these securitiesare considered the most liquid.

Municipal obligations are debt instrumentsissued by state and local governments andagencies. These are typically tax-free.

Federal Agency securities have some degreeof federal government backing. Agency issuesare typically smaller than Treasury securities,

but are similar in liquidity and trade at ahigher yield than Treasuries of the samematurity. Federal Agency issuers includeFannie Mae (Federal National MortgageAssociation), Freddie Mac (Federal Home LoanMortgage Association), Federal Home LoanBank, and Federal Farm Credit Banks FundingCorporation among others.

Bank Financial Instruments include domesticand foreign bank short-term certificates ofdeposit, time deposits, bank notes andbankers acceptances (BAs).

Commercial Paper (CP) is an unsecured

promissory note issued by a corporation for aspecific amount and a specified period of time,not to exceed 270 days. It may bear aninterest rate but is typically sold at a discount.Commercial paper is rated by credit ratingagencies.

Repurchase agreements (repos) arecollateralized transactions between asecurities dealer and an investor. The investor


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purchases a security with an agreement tosell it back to the dealer at a future date.

Most securities used are U.S. Treasury oragency securities.

There are also professionally managed MoneyMarket Mutual Funds that consist of marketablesecurities. These funds typically offerdiversified portfolios with competitive yields.Money Market Mutual Funds are an excellentinvestment choice for companies with limitedpersonnel or investment skill.

How are cash shortagesmanaged?

Unused borrowing capacity is a liquiditymanagement tool. As the old adage says, thebest time to borrow money is when you dontneed it. Defining the amount of a short-term lineof credit requires not only a reliable cashforecast, but also a thorough understanding of

seasonal revenue fluctuations, timing of majorcapital expenditures, the intra-period timing ofreceipts and disbursements and an appropriatecontingency factor to deal with the unexpected.The objectives in establishing borrowing levelsare to:

Ensure adequate funds to meet short-termcash requirements

Minimize the cost of funds

Avoid an excessive debt burden or a potentialdefault

Develop alternative sources of short-term

borrowing to maximize flexibility and theresponsiveness to sudden market shifts andopportunities

There are numerous arrangements and methodsfor managing temporary cash shortfalls. Eachcompany has to determine the best methodavailable to them to obtain short-term financing,based on its overall financial health and strategic

financial planning. The cost of short-termborrowing is determined by the lenders perceived

credit risk that is established by reviewing theborrowers current earnings, leverage, futuregrowth potential and the type of collateral, if any,securing the debt.

Short-term financing alternatives include:

Line of Credit is an agreement between thelender and the borrower that allows theborrower to access funds up to a maximumamount.

Commercial Paper (CP) is debt that is issueddirectly by the company or through its dealers.

It is an unsecured promissory note for aspecific period of time and is generally issuedat a discount. The cost of credit viacommercial paper issuance depends on thecredit worthiness of the company. Companiesissue CP to obtain cheaper, more flexible ormore available financing than is offeredthrough financial institutions.

Reverse Repurchase Agreements (reverserepos) involve a company holding short-terminvestments selling securities to a dealer withthe agreement to buy them back at specificprice and time. In essence, the company isborrowing money from the dealer and offering

the securities as collateral. Asset-Based Borrowing is a form of secured

lending based on pledging corporate assets ascollateral. The most common form of asset-based borrowing is the pledging of accountsreceivable, but also may involve collateralizinginventory, real estate (mortgage) or othertangible property.

Factoring is the sale of a title to accountsreceivable to a third party (factor) at adiscounted rate.

Securitization is a financing method in whicha company issues debt securities backed by a

pool of selected assets, such as receivables,equipment leases or auto loans. The assetshave a predictable cash flow stream, whichprovides the resource for retiring the debtsecurities.

Trade Credit cannot be overlooked as a meansof short-term borrowing. Some vendors offersubstantial trade discounts for early payment.Delaying payment for the full payment terms,


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however, can be a source of short-term cash.Economically, however, missing trade

discounts tends to be the most expensivemethod of short-term borrowing. Latepayments create significant vendorrelationship problems and will ultimatelyimpair the companys access to credit.

Does InternationalCash Management differ

significantly from the U.S.?

The international cash management market isbecoming an important focus as the economygoes global. The objectives and issues ofinternational cash management are similar todomestic cash management. The same theoriesof efficient collection of funds and informationabout funds movement apply in the internationalmarket. There are, however, additionalchallenges and issues in managing foreignexchange, cross-border funds movement and thevolatility of the global financial environment.Social and cultural differences vary widely fromU.S. practices and from country to country. Amyriad of differences exist in foreign and

domestic tax rules, payment systems,government regulations and restrictions oncross-border funds and data exchange.

While the cash management objectives remainconstant globally, the means by which they areaccomplished vary greatly.

The centralization of international cashmanagement is a trend which has beenaccelerated by developments in the Europeaneconomic and monetary union and thetechnological multi-currency reportingcapabilities of enterprise resource planning (ERP)

software programs such as SAP, Oracle andPeopleSoft. While global centralization of localreceipts and disbursements may not be feasible,there are several functions that can be andshould be managed globally. A centralizedtreasury management operation may establishglobal practices and policies for treasuryoperations such as banking service selection,internal control and reporting policies.Guidelines for international transactions, such as

purchase of foreign currency, exposure hedgingand settlement of inter-company commerce are

also generally defined on a global level.

Centralization of global cash management is mosteffectively implemented in managing intra-company funding, netting of payables andreceivables, investments, and foreign currencyexposure. In order for centralized management toaccomplish its objective, however, a great deal ofeffort and skill is required to prepare a forecastand analysis of international cash flows. Though acomplex and sometimes difficult task, it is criticalif the company is to minimize foreign currencylosses, excessive taxation and substantial profiterosion due to a lack of overall risk managementstrategy.

What resources are available tolearn more about

Cash Management?

As corporate treasury departments expand, thereare new areas of responsibility thrust upon thecash manager. Often the department lacks thepersonnel or knowledge to implement seniormanagement initiatives or effectively andsmoothly incorporate policy changes and systemsaccompanying bank mergers. When a companyexpands into an international market, it becomenecessary to manage foreign currency exposure.Acquisitions, mergers and divestitures all result inchanges to cash management procedures and bankaccount structures. Customer growth oroperational changes and attrition may exceed theability of staff to process payments.

One of a cash managers first and most importantresources is his or her banker. As discussed in thesection on banking relationships, keeping yourbanker fully informed and up to date on thecompanys plans and significant events allows thebanker to introduce services and solutionsconsistent with the companys changing needs.

There are a number of books, websites, periodicalsand seminars addressing all areas of treasury andcash management. Several are included in theAppendix.


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A number of treasury and cash managementconsulting services are available throughout theworld, with expertise in every area. Consultantscan provide recommendations and guidance infinding software solutions, defining systemrequirements, evaluating and selecting bankingproducts and services, developing investmentstrategies and policies, negotiating financialservice contracts, designing payment systemsand restructuring cash management procedures.Some firms specialize in areas such as electronicpayments, lockbox studies and design andadvisory investment programs.

Perhaps the most valuable resource for cashmanagers is a network of treasury professionals.A professional network is a sounding board, aresource for candid references and informationon service providers, banks, new services andpractices. Colleagues also share ideas, solutionsand information about new developments andproducts.


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Appendix

Web Pages

Association for Financial Professionals(Formerly the Treasury Management Association) - www.afponline.org

National Automated Clearing House Association (NACHA) - www.nacha.org

U.S. Treasury Department - www.treasury.gov

Board of Governors of the Federal Reserve System - www.federalreserve.gov

Phoenix Hecht - www.phoenixhecht.com

CJVolk Associates Treasury & Cash Management Consulting Services - www.cjvolk.com

Publications & Periodicals

Adam, Peter S & William A. Harrison, co-editors. Essentials of Cash Management. Bethesda, Md:Association for Financial Professionals, 2001.

Bort, Richard. Handbook of Corporate Management. New York, NY: Warren, Gorham & Lamont, 2001.

Leahy, Robert. Leahy Newsletter. Tustin, Ca: Leahy Newsletter, Inc.

Meckler, Jack M. The Corporate Guide to Payments System Risk. Bethesda, Md: Association for FinancialProfessionals, 1995.

Parkinson, Kenneth L. & Raymond P. Ruzek. How to Prepare an RFP for Treasury Services. Hopewell, NJ:Treasury Information Services, 2000.

Seidner, Alan G. Corporate Investments Manual: Short- and Intermediate-term Fixed-income Securities.New York, NY: Warren, Gorham & Lamont, 1989.

Seminars

Fundamentals of Cash Management, UNC Business School Executive Education at Chapel Hill, NCContact: Richard Richardson @ 919.541.9339


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5035 North 25th Street, Suite 1000Arlington, Virginia 22207

www.cjvolk.comPhone: 703-532-2424

Fax: 703-536-5765

CJVolk Associates, Inc.Treasury and Cash Management Consulting Services

CJVolk Associates, Inc.2002

Documents

Volk Fundamentals