Introduction to Corporate Finance

ONLINE CHAPTERS

The ACH, a computerised clearing facility, makes a paperless transfer of funds between the payer

and payee banks. An ACH settles accounts among participating banks; individual accounts are settled

by adjustments to the respective bank balances. ACH transfers of this type generally clear in one day.

For cash concentration, an ACH debit is initiated by the concentration bank and sent to each deposit

bank, with funds then moving from the deposit bank into the concentration bank. These transfers

can be automatically created from deposit information, and can then be centrally initiated from the

company’s headquarters through its concentration bank. A large nationwide retailer such as Myer can

easily concentrate deposits from many small deposit banks into its concentration account by using the

daily deposit information gathered from its stores’ point-of-sale systems.

Wire Transfers

The second funds transfer mechanism is a wire transfer. For investors and businesses in Australia, the

transfer of funds ‘by wire’ is effectively an electronic movement of funds from one bank account to

another, through a system of ‘correspondent banks’ that attach a fee for the service of transfer. The wire

transfer is a communication from bank to bank that removes funds from the payer’s bank and deposits

funds in the payee’s bank on a same-day basis.

Wire transfers can eliminate mail float and clearing float, and may provide processing float reductions

as well. For cash concentration, the company moves funds using a wire transfer from each deposit

account to its concentration account. Wire transfers are a substitute for ACH debit transfers, but they

are generally much more expensive: both the sending and receiving banks charge significant fees for the

transaction. Wire transfers are usually used only for high-dollar transfers, where the investment value of

the funds outweighs the cost of the transfer.

Selecting the Best Transfer Mechanism

The company must balance the benefits and costs of concentrating cash to determine the type and

timing of transfers from its lockbox accounts to its concentration account. The transfer mechanism

selected should be the one that is most profitable (that is, profit per period equals earnings on the

increased funds’ availability minus the cost of the transfer system). In general practice, most companies

use wire transfers for large transfers of funds from lockbox deposits, and use EDTs for high-volume, low-

dollar transfers from small deposit banks.

example

To demonstrate alternative transfer methods, we

consider Wagga Wagga Manufacturing (WWM) from

Chapter 18, which needs to transfer $120,000 from its

deposit account to its concentration account. It has two

choices: an electronic depository transfer (EDT) with a

total cost of $1, or a wire transfer with a total cost of

$15. Because this would be a midweek transfer, the

funds would be accelerated by one day using a wire

transfer. (Note: a Friday transfer would represent three

days of funds acceleration.) The company’s opportunity

cost for these funds is 7%.

In this example, the value of moving the funds

via wire transfer is the one day of interest that could

be earned if the funds arrived in the concentration

account today rather than tomorrow. This amount

is calculated to be $23.01 (0.07 ÷ 365 × $120,000).

Because the differential cost of the wire transfer versus

an EDT is $14 ($15 – $1), the company should use

a wire in this case: it would result in a net benefit of

$9.01 ($23.01 – $14.00).

Given the opportunity cost and transfer fees, we

could also determine the minimum amount for which a

wire transfer would be beneficial. Take the differential

cost of a wire ($14.00) and divide by the daily interest

rate (0.07 ÷ 365); in this case, the minimum transfer

amount would be $73,000 [$14.00 ÷ (0.07 ÷ 365)]. If

WWM were transferring funds on a Friday and thus

could earn three days of interest, then the minimum

transfer amount would be one-third of the standard

amount, or $24,333 ($73,000 ÷ 3).

wire transfer
An electronic communication
that removes funds from the
payer’s bank and deposits
funds in the payee’s bank
on a same-day basis via
bookkeeping entries