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^715

Companies, 2002

The general idea in such systems is to have no more than the minimum amount neces-

sary to pay bills on deposit in the bank. We discuss some approaches to accomplishing

this goal next.

Zero-Balance Accounts With a zero-balance accountsystem, the firm, in cooper-

ation with its bank, maintains a master account and a set of subaccounts. When a check

written on one of the subaccounts must be paid, the necessary funds are transferred in

from the master account. Figure 20.5 illustrates how such a system might work. In this

case, the firm maintains two disbursement accounts, one for suppliers and one for pay-

roll. As shown, if the firm does not use zero-balance accounts, then each of these ac-

counts must have a safety stock of cash to meet unanticipated demands. If the firm does

use zero-balance accounts, then it can keep one safety stock in a master account and

transfer the funds to the two subsidiary accounts as needed. The key is that the total

amount of cash held as a buffer is smaller under the zero-balance arrangement, which

frees up cash to be used elsewhere.

Controlled Disbursement Accounts With a controlled disbursement account

system, almost all payments that must be made in a given day are known in the morn-

ing. The bank informs the firm of the total, and the firm transfers (usually by wire) the

amount needed.

INVESTING IDLE CASH

If a firm has a temporary cash surplus, it can invest in short-term securities. As we have

mentioned at various times, the market for short-term financial assets is called the

CONCEPT QUESTIONS

20.4a Is maximizing disbursement float a sound business practice?

20.4bWhat is a zero-balance account? What is the advantage of such an account?

688 PART SEVEN Short-Term Financial Planning and Management

FIGURE 20.5

No zero-balance accounts

Payroll account Supplier account

Safety stocks

Two zero-balance accounts

Master account

Safety stock

Cash

transfers

Cash

transfers

Payroll account Supplier account

With no zero-balance accounts, separate safety stocks must

be maintained, which ties up cash unnecessarily. With zero-

balance accounts, the firm keeps a single safety stock of cash

in a master account. Funds are transferred into disbursement

accounts as needed.

Zero-Balance Accounts

zero-balance account
A disbursement account
in which the firm
maintains a zero
balance, transferring
funds in from a master
account only as needed
to cover checks
presented for payment.

controlled disbursement
account
A disbursement account
to which the firm
transfers an amount that
is sufficient to cover
demands for payment.

20.5