Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VII. Short−Term Financial

Planning and Management

20. Cash and Liquidity
    Management

© The McGraw−Hill^705

Companies, 2002

$4,500/30

$150

This means that, on an average day, your book balance is $150 less than your available

balance, representing a $150 average disbursement float.

Things are only a little more complicated when there are multiple disbursements or re-

ceipts. To illustrate, suppose Concepts, Inc., receives two items each month as follows:

Processing and

Amount availability delay Total float

Item 1: $5,000,000  9 $45,000,000

Item 2: $3,000,000  5 $15,000,000

Total $8,000,000 $60,000,000

The average daily float is equal to:

Average daily float  [20.1]

$2 million

So, on an average day, there is $2 million that is uncollected and not available.

Another way to see this is to calculate the average daily receipts and multiply by the

weighted average delay. Average daily receipts are:

Average daily receipts $266,666.67

Of the $8 million total receipts, $5 million, or^5 ⁄ 8 of the total, is delayed for nine days.

The other^3 ⁄ 8 is delayed for five days. The weighted average delay is thus:

Weighted average delay (5/8) 9 days (3/8) 5 days

5.625 1.875 7.50 days

The average daily float is thus:

Average daily float Average daily receipts Weighted average delay [20.2]

$266,666.67 7.50 days $2 million

Some Details In measuring float, there is an important difference to note between

collection and disbursement float. We defined float as the difference between the firm’s

available cash balance and its book balance. With a disbursement, the firm’s book bal-

ance goes down when the check is mailed,so the mailing time is an important compo-

nent in disbursement float. However, with a collection, the firm’s book balance isn’t

increased until the check is received,so mailing time is not a component of collection

float.

This doesn’t mean that mailing time is not important. The point is that when collec-

tion floatis calculated, mailing time should not be considered. As we will discuss, when

total collection timeis considered, the mailing time is a crucial component.

Also, when we talk about availability delay, how long it actually takes a check to

clear isn’t really crucial. What matters is how long we must wait before the bank grants

availability, that is, use of the funds. Banks actually have availability schedules that are

used to determine how long a check is held based on time of deposit and other factors.

$8 million

30

Total receipts

Total days

$60 million

30

Total float

Total days

678 PART SEVEN Short-Term Financial Planning and Management