Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVII. Short−Term Financial
Planning and Management20. Cash and Liquidity Management
(^706) © The McGraw−Hill
Companies, 2002
Beyond this, availability delay can be a matter of negotiation between the bank and a
customer. In a similar vein, for outgoing checks, what matters is the date our account is
debited, not when the recipient is granted availability.
Cost of the Float The basic cost of collection float to the firm is simply the opportu-
nity cost of not being able to use the cash. At a minimum, the firm could earn interest on
the cash if it were available for investing.
Suppose the Lambo Corporation has average daily receipts of $1,000 and a weighted
average delay of three days. The average daily float is thus 3 $1,000 $3,000. This
means that, on a typical day, there is $3,000 that is not earning interest. Suppose Lambo
could eliminate the float entirely. What would be the benefit? If it costs $2,000 to elim-
inate the float, what is the NPV of doing so?
Figure 20.1 illustrates the situation for Lambo. Suppose Lambo starts with a zero
float. On a given day, Day 1, Lambo receives and deposits a check for $1,000. The cash
will become available three days later on Day 4. At the end of the day on Day 1, the
book balance is $1,000 more than the available balance, so the float is $1,000. On
Day 2, the firm receives and deposits another check. It will collect three days later on
Day 5. Now, at the end of Day 2, there are two uncollected checks, and the books show
a $2,000 balance. The bank, however, still shows a zero available balance; so the float
is $2,000. The same sequence occurs on Day 3, and the float rises to a total of $3,000.
On Day 4, Lambo again receives and deposits a check for $1,000. However, it also
collects $1,000from the Day 1 check. The change in book balance and the change in
available balance are identical, $1,000; so the float stays at $3,000. The same thing
happens every day after Day 4; the float therefore stays at $3,000forever.^1
Figure 20.2 illustrates what happens if the float is eliminated entirely on some day tin
the future. After the float is eliminated, daily receipts are still $1,000. The firm collects
the same day because the float is eliminated, so daily collections are also still $1,000. As
Figure 20.2 illustrates, the only change occurs the first day. On that day, as usual, Lambo
collects $1,000 from the sale made three days before. Because the float is gone, it also
collects on the sales made two days before, one day before, and that same day, for an ad-
ditional $3,000. Total collections on Day tare thus $4,000instead of $1,000.
What we see is that Lambo generates an extra $3,000 on Day tby eliminating the
float. On every subsequent day, Lambo receives $1,000 in cash just as it did before the
float was eliminated. Thus, the only change in the firm’s cash flows from eliminating
CHAPTER 20 Cash and Liquidity Management 679
FIGURE 20.1
Beginning float
Checks received
Checks cleared
(cash available)
Ending float$ 0
1,000- $1,000
12 345Day$1,000
1,000- $2,000
$2,000
1,000- $3,000
$3,000
1,000- 1,000
$3,000
$3,000
1,000- 1,000
$3,000
...
...
......
...Buildup of the FloatTry http://www.cfoasia.comfor
an international view on
cash management.(^1) This permanent float that exists forever is sometimes called the steady-state float.