486 Part 6 Working Capital Management, Forecasting, and Multinational Financial Management
15-6a Currency
Fast-food operators, casinos, hotels, movie theaters, and a few other businesses
hold substantial amounts of currency; but the importance of currency has decreased
over time due to the rise of credit cards, debit cards, and other payment mecha-
nisms. Companies such as McDonald’s need to hold enough currency to support
operations; but if they held more, this would raise capital costs and tempt robbers.
Each! rm decides its own optimal level; but even for retailers, currency generally
represents a small part of total cash holdings.^915-6b Demand Deposits
Demand (or checking) deposits are far more important than currency for most
businesses. These deposits are used for transactions—paying for labor and raw
materials, purchasing! xed assets, paying taxes, servicing debt, paying divi-
dends, and so on. However, commercial demand deposits typically earn no
interest; so! rms try to minimize their holdings while still ensuring that they are
able to pay suppliers promptly, take trade discounts, and take advantage of bar-
gain purchases. The following techniques are used to optimize demand deposit
holdings:- Hold marketable securities rather than demand deposits to provide liquidity. When
the! rm holds marketable securities, the need for demand deposits is reduced.
For example, if a large bill requiring immediate payment comes in unexpect-
edly, the treasurer can simply call a securities dealer, sell some securities, and
have funds deposited in the! rm’s checking account that same day. Securities
pay interest whereas demand deposits do not, so holding securities in lieu of
demand deposits increases pro! ts. - Borrow on short notice. Firms can establish lines of credit under which they can
borrow with just a telephone call if and when they need extra cash. Note,
though, that they may have to pay fees for those commitments and the cost of
those fees must be considered when deciding to use borrowing capacity
rather than securities to provide liquidity. - Forecast payments and receipts better. The better the! rm can forecast its cash
in" ows and out" ows, the smaller its needs for funds to meet unexpected
requirements. Therefore, improving in" ow/out" ow forecasts lessens the need
to hold liquid assets and thus reduces the required amount of working capital.
The cash budget is the key tool used to improve cash forecasts. - Speed up payments. Firms can take actions to get their cash receipts faster. For
example, they can use lockboxes, which are post of! ce boxes operated by
banks. Suppose a New York! rm sells to customers all across the country. If it
sends out bills and has customers make payments to its New York headquar-
ters, time will be lost in waiting on the mail, in opening envelopes, in deposit-
ing checks in the bank, and in waiting for the bank to clear the checks to make
sure they are good. To speed up this process, the! rm can direct customers to
send payments to a post of! ce box in the customer’s local area, then have a
bank empty the box several times each day and start the collection process. If
a! rm’s receipts average $1 million per day and if the use of lockboxes can
reduce the delay in obtaining usable cash from 5 days to 1 day, the! rm will
reduce funds in transit from $5 million to $1 million and thus receive an
Lockbox
A post office box operated
by a bank to which
payments are sent. Used
to speed up effective
receipt of cash.Lockbox
A post office box operated
by a bank to which
payments are sent. Used
to speed up effective
receipt of cash.(^9) In “olden days,” currency was also held as a store of value, for use during emergencies, for use in making bargain
purchases, and the like. That is true today only in undeveloped parts of the world.