Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVII. Short−Term Financial
Planning and Management- Cash and Liquidity
Management
(^704) © The McGraw−Hill
Companies, 2002
Float Management
Float management involves controlling the collection and disbursement of cash. The ob-
jective in cash collection is to speed up collections and reduce the lag between the time
customers pay their bills and the time the cash becomes available. The objective in cash
disbursement is to control payments and minimize the firm’s costs associated with mak-
ing payments.
Total collection or disbursement times can be broken down into three parts: mailing
time, processing delay, and availability delay:
1.Mailing timeis the part of the collection and disbursement process during which
checks are trapped in the postal system.
2.Processing delayis the time it takes the receiver of a check to process the payment
and deposit it in a bank for collection.
3.Availability delayrefers to the time required to clear a check through the banking
system.
Speeding up collections involves reducing one or more of these components. Slowing
up disbursements involves increasing one of them. We will describe some procedures
for managing collection and disbursement times later. First, we need to discuss how
float is measured.
Measuring Float The size of the float depends on both the dollars and the time delay
involved. For example, suppose you mail a check for $500 to another state each month.
It takes five days in the mail for the check to reach its destination (the mailing time) and
one day for the recipient to get over to the bank (the processing delay). The recipient’s
bank holds out-of-state checks for three days (availability delay). The total delay is 5
1 3 9 days.
In this case, what is your average daily disbursement float? There are two equivalent
ways of calculating the answer. First, you have a $500 float for nine days, so we say that
the total float is 9 $500 $4,500. Assuming 30 days in the month, the average daily
float is $4,500/30 $150.
Alternatively, your disbursement float is $500 for 9 days out of the month and zero
the other 21 days (again assuming 30 days in a month). Your average daily float is thus:
Average daily float (9 $500 21 0)/30
9/30 $500 21/30 0
CHAPTER 20 Cash and Liquidity Management 677
After you write the $1,000 check, you show a balance of $4,000 on your books, but the
bank shows $5,000 while the check is clearing. The difference is a disbursement float of
$1,000.
After you deposit the $2,000 check, you show a balance of $6,000. Your available balance
doesn’t rise until the check clears. This results in a collection float of $2,000. Your net float
is the sum of the collection and disbursement floats, or $1,000.
Overall, you show $6,000 on your books. The bank shows a $7,000 balance, but only
$5,000 is available because your deposit has not been cleared. The discrepancy between your
available balance and your book balance is the net float ($1,000), and it is bad for you. If you
write another check for $5,500, there may not be sufficient available funds to cover it, and it
might bounce. This is the reason that financial managers have to be more concerned with
available balances than book balances.
For a real-world example
of float management
services, visit
http://www.epaymentsystems.
com.