592 CHAPTER 16 Working Capital Management
Cash Management Techniques
Most business is conducted by large firms, many of which operate regionally, nation-
ally, or even globally. They collect cash from many sources and make payments from a
number of different cities or even countries. For example, companies such as IBM,
General Motors, and Hewlett-Packard have manufacturing plants all around the
world, even more sales offices, and bank accounts in virtually every city where they do
business. Their collection points follow sales patterns. Some disbursements are made
from local offices, but most are made in the cities where manufacturing occurs, or else
from the home office. Thus, a major corporation might have hundreds or even thou-
sands of bank accounts, and since there is no reason to think that inflows and outflows
will balance in each account, a system must be in place to transfer funds from where
they come in to where they are needed, to arrange loans to cover net corporate short-
falls, and to invest net corporate surpluses without delay. We discuss the most com-
monly used techniques for accomplishing these tasks in the following sections.Cash Flow Synchronization
If you as an individual were to receive income once a year, you would probably put it
in the bank, draw down your account periodically, and have an average balance for the
year equal to about half your annual income. If instead you could arrange to receive
income weekly and to pay rent, tuition, and other charges on a weekly basis, and if you
were confident of your forecasted inflows and outflows, then you could hold a tiny av-
erage cash balance.
Exactly the same situation holds for businesses—by improving their forecasts and
by timing cash receipts to coincide with cash requirements, firms can hold their trans-
actions balances to a minimum. Recognizing this, utility companies, oil companies,
credit card companies, and so on, arrange to bill customers, and to pay their own bills,
on regular “billing cycles” throughout the month. This synchronization of cash
flowsprovides cash when it is needed and thus enables firms to reduce the cash bal-
ances needed to support operations.Speed Up the Check-Clearing Process
When a customer writes and mails a check, the funds are not available to the receiving
firm until the check-clearingprocess has been completed. The bank must first make
sure that the deposited check is good and the funds are available before it will give
cash to the company.
In practice, it may take a long time for a firm to process incoming checks and ob-
tain the use of the money. A check must first be delivered through the mail and then
be cleared through the banking system before the money can be put to use. Checks re-
ceived from the customers in distant cities are especially subject to delays because of
mail delays and also because more banks are involved. For example, assume that we re-
ceive a check and deposit it in our bank. Our bank must send the check to the bank on
which it was drawn. Only when this latter bank transfers funds to our bank are the
funds available for us to use. Checks are generally cleared through the Federal Reserve
System or through a clearinghouse set up by the banks in a particular city. Of course,
if the check is deposited in the same bank on which it was drawn, that bank merely
transfers funds by bookkeeping entries from one depositor to another. The length of
time required for checks to clear is thus a function of the distance between the payer’s
and the payee’s bank. In the case of private clearinghouses, clearing can range from
one to three days. Checks are generally cleared through the Federal Reserve System in