Introduction to Corporate Finance

19: Cash, Payables and Liquidity Management

■ Cash managers are also responsible

for identifying and quantifying financial

relationships, forecasting cash flow,

investing and borrowing and information

management. In large companies, they

must manage the company’s cash position;

in small companies, they set target cash

balances based on transactions requirements

and minimum balances set by their bank.

■ In managing collections, the cash manager

attempts to reduce collection float using

various collection systems, which include

mail-based systems, and electronic systems.

Large companies whose customers are

geographically dispersed commonly use

lockbox systems, although small companies

can also benefit from them.

■ Companies use cash concentration to

bring lockbox and other deposits together

into one bank, often a concentration

bank. Companies often use automated

clearinghouse (ACH) debit transfers (also

known as electronic depository transfer

(EDT)) and wire transfers to transfer

funds from the depository bank to the

concentration bank.

■ The objective of managing the company’s

accounts payable is to pay accounts as

slowly as possible without damaging

the company’s credit rating and supplier

relations. If a supplier offers a cash discount,

the company in need of short-term funds

must determine the interest rate associated

with not taking the discount (and paying

at the end of the credit period) and then

compare this rate with the company’s

lowest-cost short-term borrowing

alternative. If it can borrow elsewhere at

a lower cost, the company should take

the discount and pay early; otherwise, it

should not.

■ Financial managers use such disbursement

products and methods as zero-balance

accounts (ZBAs), controlled disbursement

and positive pay. Some of the key

developments in accounts payable and

disbursements are integrated accounts

payable, use of purchasing or procurement

cards, imaging services and a number of

measures for preventing fraud.

■ The cash manager will meet the company’s

transactions, safety and speculative motives

by holding cash and short-term investments

(often called marketable securities). The

short-term investments allow the company

to earn a return on temporary cash balances.

Investment policies and guidelines for

management of short-term investments

should be established.

■ Small companies are likely to invest their

short-term surpluses in money market

mutual funds. Larger companies will invest in

any of a variety of short-term, fixed-income

securities.

■ Short-term borrowing can be obtained

through the issuance of commercial paper,

primarily by large companies, and through

overdraft lines of credit. Most short-term

borrowing occurs at a base rate – usually, the

prime rate or LIBOR – plus a spread reflecting

the borrower’s relative riskiness. The effective

borrowing rate (EBR) can be calculated to

capture both the interest costs and other fees

associated with a short-term loan.

■ Companies can also issue short-term

commercial paper, in the form of bills of

exchange. If these are commercial bills,

they allow companies to raise funds for

non-specific purposes. The costs of these

unsecured borrowings can be reduced

if the bills are accepted by a bank, or

endorsed by a bank.

LO19.2

LO19.4

LO19.4

LO19.5

LO19.6

IMPORTANT EQUATIONS

19.1 Net benefit (cost) of lockbox = (FVR × ra) – LC

19.2

()()

=

−

×

−

r

d

1 dCPDP

365

discount

LO19.2

LO19.3

LO19.5