Suppose FordÔÇ™s stock price is $50 per share, and there are 1.14 billion shares of Ford
outstanding. Assume that daily sales average $400 million. Now suppose that techno-
logical improvements in the check-clearing process reduce availability float from 4 days
to 2 days. What would happen to the stock price? How much should Ford be willing to
pay for a new computer system that would reduce availability float by 2 days?
Several kinds of delay create float, so people in the cash management business refer to
several kinds of float. Figure 2.5 shows the three sources of float:
ÔÇó The time that it takes to mail a check.
ÔÇó The time that it takes the company to process the check after it has been received.
ÔÇó The time that it takes the bank to clear the check and adjust the firmÔÇ™s account.
206 SECTION TWO
Delays create float. Each
heavy arrow represents a Check mailed
source of delay. Recipients
try to reduce delay to get Mail float
available cash sooner. Payers
prefer delay so they can use Check received
their cash longer. Recipient Payer sees
sees delays same delays
as avail- as payment
ability float float
Check clears Check clears
Cash available Check charged to
to recipient payerÔÇ™s account
The total collection time is the sum of these three sources of delay.
Delays that help the payer hurt the recipient. Recipients try to speed up
collections. Payers try to slow down disbursements. Both attempt to minimize
You probably have come across attempts by companies to reduce float in your own
financial transactions. For example, some stores now encourage you to pay bills with
your bank debit card instead of a credit card. The payment is automatically debited from
your bank account on the day of the transaction, which eliminates the considerable float
you otherwise would enjoy until you were billed by your credit card company and paid
your bill. Similarly, many companies now arrange preauthorized payments with their
customers. For example, if you have a mortgage payment on a house, the lender can
arrange to have your bank account debited by the amount of the payment each month.
The funds are automatically transferred to the lender. You save the work of paying the
bill by hand, and the lender saves the few days of float during which your check would
have been processed through the banking system. The nearby box discusses tactics that
banks use to maximize their income from float.
SPEEDING UP COLLECTIONS
One way to speed up collections is by a method known as concentration banking. In
this case customers in a particular area make payments to a local branch office rather
than to company headquarters. The local branch office then deposits the checks into a
whereby customers make
local bank account. Surplus funds are periodically transferred to a concentration ac-
payments to a regional
count at one of the companyÔÇ™s principal banks.
collection center which
Concentration banking reduces float in two ways. First, because the branch office is
transfers funds to a principal
nearer to the customer, mailing time is reduced. Second, because the customers are
local, the chances are that they have local bank accounts and therefore the time taken
to clear their checks is also reduced. Another advantage is that concentration brings
FINANCE IN ACTION
High-Tech Tactics Let Banks
Keep the ÔÇťFloatÔÇŁ
current five-day limit. The Fed started putting limits on
If anybody knows time is money, itÔÇ™s banks.
how long banks can hold customer funds about a
And in the electronic age, banks are becoming more
decade ago, in response to numerous customer com-
expert at the movement of money: racing it to them-
plaints that deposits were being tied up for no reason.
selves fasterÔÇ” but sometimes slamming on the brakes
Clearly, paper checks are moving faster now. About
when you deposit a check. So donÔÇ™t expect your funds
83% of checks currently arrive back at their bank of ori-
to be available to you any quicker.
gin within five business days, up from 73% in 1990, ac-
To zip checks along and reduce the ÔÇť floatÔÇŁ ÔÇ” or the
cording to the Fed. Major banks now use a fleet of 30
downtime between when a check is written and when
Lear jets owned by AirNet Systems Inc. of Columbus,
the funds are actually drawn from an accountÔÇ” banks
Ohio, to whiz checks across the country.
are turning to everything from speedier check-reading
But other bank-policy changes are reducing the
machines to zooming jet planes loaded with bundles of
breathing room people have long enjoyed with checks.
One new tactic is requiring that loan payments be re-
First Union Corp., for one, has begun installing scan-
ceived by their due date; in the past, banks usually con-
ning devices at HairCuttery salons so when a patron
sidered a payment made if it was postmarked by the
hands over an ordinary check for a shampoo and cut, a
machine reads it and swiftly deducts the amount from
For the time being, the vast majority of checks are
the checking accountÔÇ” just as debit cards currently do.
covered by the FedÔÇ™s five-day rule, but a check may be
But when it comes to moving funds into a cus-
held longer by the bank under certain circumstances. A
tomerÔÇ™s account, sometimes the pace is suddenly a lot
check, for instance, might be unusually large or it might
be deposited by a customer who has repeatedly over-
There is big business in playing traffic cop to the flow
drawn his account. But even in those cases, the bank
of checks. At any given moment, an estimated $140 bil-
must notify the customer when a deposit will be held for
lion in checks are en route to a bankÔÇ” a mountain of
a week or longer, and explain exactly when the funds
paper that could earn roughly $20 million in interest
will be available for withdrawal.
every day, estimates David Medeiros, an analyst at
Tower Group, a bank consultancy in Needham, Mass.
Responding to the accelerated movement of money,
Source: Rick Brooks, ÔÇťHigh-Tech Tactics Let Banks Keep the
the government may clamp down on banks. A pending ÔÇ˜Float,ÔÇ™ ÔÇŁ The Wall Street Journal, June 3, 1999, p. B1. Reprinted with
Federal Reserve Board proposal, which banks oppose, permission of The Wall Street Journal. Copyright 1999 Dow Jones &
would cut the maximum number of days a bank can put Company. All Rights Reserved Worldwide.
a hold on most checks to four business days from the
many small balances together in one large, central balance, which then can be invested
in interest-paying assets through a single transaction. For example, when Amoco
streamlined its U.S. bank accounts, it was able to reduce its daily bank balances in
nonÔÇ“interest-bearing accounts by almost 80 percent.1
Unfortunately, concentration banking also involves additional costs. First, the com-
pany is likely to incur additional administrative costs. Second, the companyÔÇ™s local bank
needs to be paid for its services. Third, there is the cost of transferring the funds to the
concentration bank. The fastest but most expensive arrangement is wire transfer, in
which funds are transferred from one account to another via computer entries in the ac-
counts. A slower but cheaper method is a depository transfer check, or DTC. This is a
1 ÔÇťAmoco Streamlines Treasury Operations,ÔÇŁ The Citibank Globe, November/December 1998.
208 SECTION TWO
preprinted check used to transfer funds between specified accounts. The funds become
available within 2 days.
Wire transfer makes more sense when large funds are being transferred. For exam-
ple, at a daily interest rate of .02 percent, the daily interest on a $10 million payment
would be $2,000. Suppose a wire transfer costs $10. It clearly would pay to spend $10
to save 2 daysÔÇ™ float. On the other hand, it would not be worth using wire transfer for
just $5,000. The extra 2 daysÔÇ™ interest that you pick up amounts to only $2, not nearly
enough to justify the extra expense of the wire transfer.
Break-Even Wire Transfer Amount
Suppose the daily interest rate is .02 percent and that a wire transfer saves 2 days of float
but costs $10 more than a depository transfer check. How large a transfer is necessary
to justify the additional cost of a wire transfer?
The interest savings are .02 percent per day ├— 2 days ├— funds to be transferred. So
the break-even level of funds to be transferred is found by solving
.0004 ├— size of transfer = $10
Size of transfer = = $25,000
The cost of the wire transfer can be justified for any transfer above this amount.
Often concentration banking is combined with a lock-box system. In a lock-box sys-
tem, you pay the local bank to take on the administrative chores. It works as follows.
System whereby customers
The company rents a locked post office box in each principal region. All customers
send payments to a post
within a region are instructed to send their payments to the post office box. The local
office box and a local bank
bank empties the box at regular intervals (as often as several times per day) and deposits
collects and processes
the checks in your companyÔÇ™s local account. Surplus funds are transferred periodically
to one of the companyÔÇ™s principal banks.
How many collection points do you need if you use a lock-box system or concen-
tration banking? The answer depends on where your customers are and on the speed of
the United States mail.
Suppose that you are thinking of opening a lock box. The local bank shows you a map
of mail delivery times. From that and knowledge of your customersÔÇ™ locations, you
come up with the following data:
Average number of daily payments to lock box = 150
Average size of payment = $1,200
Rate of interest per day = .02 percent
Saving in mailing time = 1.2 days
Saving in processing time = .8 day
On this basis, the lock box would reduce collection float by
150 items per day ├— $1,200 per item ├— (1.2 + .8) days saved = $360,000
Cash and Inventory Management 209
Invested at .02 percent per day, that gives a daily return of
.0002 ├— $360,000 = $72
The bankÔÇ™s charge for operating the lock-box system depends on the number of
checks processed. Suppose that the bank charges $.26 per check. That works out to 150
├— $.26 = $39.00 per day. You are ahead by $72.00 ÔÇ“ $39.00 = $33.00 per day, plus what-
ever your firm saves from not having to process the checks itself.
Our example assumes that the company has only two choices. It can do nothing or it
can operate the lock box. But maybe there is some other lock-box location, or some
mixture of locations, that would be still more effective. Of course, you can always find
this out by working through all possible combinations, but many banks have computer
programs that find the best locations for lock boxes.2
How will the following conditions affect the price that a firm should be willing to pay
for a lock-box service?
a. The average size of its payments increases.
b. The number of payments per day increases (with no change in average size of pay-
c. The interest rate increases.
d. The average mail time saved by the lock-box system increases.
e. The processing time saved by the lock-box system increases.
Speeding up collections is not the only way to increase the net float. You can also do
this by slowing down disbursements. One tempting strategy is to increase mail time. For
example, United Carbon could pay its New York suppliers with checks mailed from
Nome, Alaska, and its Los Angeles suppliers with checks mailed from Vienna, Maine.
But on second thought you will realize that these kinds of post office tricks are un-
likely to help you. Suppose you have promised to pay a New York supplier on March
29. Does it matter whether you mail the check from Alaska on the 26th or from New
York on the 28th? Such mailing games would buy you time only if your creditor cares
more about the date you mailed the check than the day it arrives. This is unlikely: with
the notable exception of tax returns sent to the IRS, mailing dates are irrelevant. Of
course you could use a remote mailing address as an excuse to pay late, but thatÔÇ™s a trick
easily seen through. If you have to pay late, you may as well mail late.
Remote Disbursement. There are effective ways of increasing payment float, how-
ever. For example, suppose that United Carbon pays its suppliers with checks written
on a New York City bank. From the time that the check is deposited by the supplier,
there will be an average lapse of little more than a day before it is presented to
United CarbonÔÇ™s bank for payment. The alternative is for United Carbon to pay its sup-
pliers with checks mailed to arrive on time, but written on a bank in Helena, Montana;