Cash Management

Cash Cycle Factors that influence the desired level of cash Optimal cash inventories Short-term investment strategies

The Manager

Managing an entitys Resources

Cash Management Inventory Management Working Capital Management Investment in Human Capital Long-term Assets Accounts Receivable

Resource Decisions
Investment Decisions Operating Decisions Human Resources Decisions

Life cycle effects, Business cycle, public events, etc.

Recruitment, Selection Training, Productivity Performance Appraisal Compensation Unions & Labor Relations

Cash Inflows

Value Creation

Information Decisions

Economics of Information Database Management Data Modeling IS Planning & Development

Discount Rate

Financing Decisions

Debt vs. Tax Financing

Cost of Capital

Financial Markets

Overview
ST finl planning = deals w/ short-lived assets and liabilities (working capital management);
concerned w/ 1) size of investment in CA like cash, A/R, Inventorya tool is cash budget analysis and 2) how to finance ST assetsa tool is performing credit analysis

Managing WC involves determing:

How much to invest in CA? - CA vs. FA - Nature of activities/programs

In each CA? - Cash, A/R, Inventory - Cash Mgt - A/R is Credit Mgt - Inv = POM & Cash balance models

Our objectives
Learn about the Cash Cycle Understand the factors that influence the desired level of cash Learn two models that calculate the optimal level of cash Gain an overview of what factors/areas are inputs to a cash budget and how they affect the cash balance

Objectives of Public Money Managers

Bringing the entitys cash resources within control Achieving optimum conservation and utilization of the funds

Key areas of Public Cash Management

Organization Collection and disbursement of funds Netting of interagency payments Investment of excess funds Optimal level of cash balances Cash planning and budgeting Bank relations

Treasury Management of Cash Balances

Operate with smaller amount of cash Supervision is centralized Better service from banks Proper allocation of funds

How much cash should a organization keep on hand?

Enough cash to make payments when needed. (transactions motive)
(Daily or Weekly Cash Budget helpful)

Additional cash may be held for unexpected requirements. (precautionary motive)

The size of the minimum cash balance depends on:

How quickly and cheaply a organization can raise cash when needed. How accurately managers can predict cash requirements.
(Cash Budget helpful)

How much precautionary cash the managers need for emergencies.

The organizations maximum cash balance depends on:

Available (short-term) investment opportunities
e.g. money market funds, CDs, commercial paper

Expected return on investment opportunities.

e.g. If expected returns are high, organizations should be quick to invest excess cash

Transaction cost of withdrawing cash and making an investment Demand for Cash for daily transactions
(Cash Budget helpful)

Consider Cash an Inventory

the trade-offs: - hold little cash = invest An inventory approach to Cash remainder in M/S to earn interest Balance decisions: Grantsville has a daily demand for cash of $10,000. Grantsvilles too little cash = incur transactions state investment pool - if hold treasurer invests excess cash in the that earns to meet cash needsorder to transfer funds from the state pool, costs .01% per day. In Grantsville must pay a transaction cost of $20. How much cash should it transfer when it runs out. (Grantsville can complete the cash transfer electronically so it waits hold lots of cash = forgo investing in M/S - until the cash balance is zero). and earning interest

Optimal Cash Balance via Baumol Model

50000000 1002 504 339.3333333 258 210

M = $10,000

r = .01% .0001

TC = $20

Cost ($)

Z*= [(2M*TC)/r] Z*
Z = $63,246

Total Costs Holding Costs: (Z/2)*r

Order Costs:(M/Z)*TC

Z*

Order Quantity (Z)

Problems with the Baumol Model

Cash flows may not be very predictable, much less constant Treasurers may want a safety stock of cash

The Miller - Orr Model

The Miller-Orr Model provides a formula for determining the optimum cash balance (Z), the point at which to sell securities to raise cash (lower limit L) and when to invest excess cash by buying securities and lowering cash holdings (upper limit H). Depends on:
transaction costs of buying or selling securities variability of daily cash (incorporates uncertainty) return on short-term investments

The Miller - Orr Model

Upper Limit Buy Securities

L
Lower Limit Sell Securities Days of the Month

The Miller-Orr Model - Target Cash Balance (Z)

3

Z=

3 x TC x V +L 4xr

where: TC = transaction cost of buying or selling securities V = variance of daily cash flows r = daily return on short-term investments L = minimum cash requirement

The Miller-Orr Model - Target Cash Balance (Z)

Example: Suppose that short-term securities yield 5% per year and it costs the organization $50 each time it buys or sells securities (TC). The daily variance of cash flows is $1000 (V) and your bank requires $1,000 minimum checking account balance (L).*

Z=

3 x 50 x 1000 4 x .05/360

+ $1,000

= $3,000 + $1,000 = $4,000

The Miller-Orr Model - Upper Limit

The upper limit for the cash account (H) is determined by the equation: H = 3Z - 2L where: Z = Target cash balance L = Lower limit In the previous example: H = 3 ($4,000) - 2($1,000) = $10,000

The Miller - Orr Model

Upper Limit Buy Securities

$10,000

$4000 $1000

Lower Limit

Sell Securities Days of the Month

Cash Pooling
Centralized cash management involves transfer of an agencys cash in excess of minimal operating requirements into a centrally managed account also known as a cash pool. Procedure and Benefits

Investment of excess funds

The Collection & Disbursement of Public Funds Managing Cash Balances Safety Liquidity Maximize pool of funds available for investment
Concentration Accounts Zero-balance accounts

Highest yield

Controlling Cash Collection & Disbursement Dual responsibility Receipts maintained in a location separate from cash & checks Certification of vouchers

Collection of funds
Need for accelerating collections How to accelerate collection of receivables

Disbursement of funds
Importance of disbursement of funds Review of disbursements
Payment instruments being used (checks, drafts, wire transfers, etc.) Bank charges and internal costs Techniques being used Time involved for processing of instruments

Payments Netting in Public Cash Management

Need for payments netting Procedure involved
Only netted amount is transferred (bilateral netting) Netting center (multilateral netting)

Our objectives
Learn about the Cash Cycle Understand the factors that influence the desired level of cash Learn two models that calculate the optimal level of cash Gain an overview of what factors/areas are inputs to a cash budget and how they affect the cash balance

Stop Here

Payments netting in Public Cash Management (contd.)

Payments Netting in Public Cash Management (contd.)

Cash Planning and Budgeting

Cash Planning and Budgeting (contd.)