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Cash and Marketable See
Ccurities Management 928
REVIEW NOTES
sic concepts
B3
sa medium of exchange. Itis the
i Most co) Si
jue of assets received and nvenient way to measure
cash!
asset parted with in an arm's length
the v2
ionsaclion. of exch i
a medium of exchange is must be used or invested in business
gertaking OF it will lose its opportunity of earnings. This gives rise to the
sortunity costs of holding excess cash.
tes includes currencies (eg, coins and bills), checks, demand deposits,
checking accounts and cash equivalents that are used for working capital
operations :
technically, cash is an idle asset, unless an enterprise has a business
purpose of maintaining it. The ideal cash balance therefore should be
ef0
the areas of concern in cash management includes
174 determining the optimum cash balance to be maintained,
47.2 the synchronization of cash inflows and outflows,
47.3. identifying the temporary investments to place temporary excess
cash,
17.4 knowing the effective interest rate of borrowing and other short-
term financing, and
17.5 linking cash flows to receivables collection period and inventory
conversion days (ie, days to obtain and sell inventory)
Convenience as to unit of measure is not a controlling variable in
developing an enterprise's applicable cash management technique.
_ &ffective cash management is still measured using the cost-benefit
criterion.
Reasons for maintaining a minimum cash balance
There are three (3) practical reasons for holding cash, such as:
24.1 Transactional motive. This is maintained to ‘meet routine
payments of operating expenses where the use of check, credit
card, ATM, coupons, and other modern means of payments may
be impractical under the circumstances. Examples of this type of
cash are petty cash, change fund, and vale fund. Another reason
for holding cash balance is to comply with contractual
requirements, covenants, and provisions of applicable laws such
as compensating cash balances, interest funds, and dividend
fund. 2.2
3.2
Cash and Marketable Securities Management
Cha
ey
; i Speculations affe '
tive motive. — ct
21.2 Specirton pattern, investment Opportunities Oy
cine When changes in business Environment Owth
ve ready cash to meet pPortunPPen
in the business environment (ig es b,!
f cash is optimized to reduce prices "abe ty
always pays to ha
about by changes
where the power 0 7
in business environment and conditions may be related t
ri
industry life cycles and economic cycle © Prog
at to cloth the nature of business environment
pays to have ready cash especially at times of ‘eo
slowdown. : : on
2.1.3 Contingency motive (or precautionary motive) Businesell
conduct their operations in a web of complicated and una, Ss
environment. Maintaining a fund for precautionary reasong a i
of the wisest strategies in business to hedge against diversi
(ie, investment risk and operating risk) and NON-diversifgy
business risk (ie., financial risk) in order to minimize the
doing business (ie. cost of money). Examples of busin
uncertainties are strikes, fires, competitors’ marketing Campaig
changes in laws and technology, seasonal and cyclical patte
and trends in social demographics.
The amount of cash to be held normally depends on the following factors:
2.2.1 Cash management policies.
2.2.2 Current liquidity position.
2.2.3 Management's liquidity and preferences.
2.2.4 Schedule of debt maturity.
2.2.5 The firm's ability to borrow.
2.2.6 Forecasted short and long-term cash flows. :
2.2.7 The probabilities of different cash flows under vari
circumstances.
Cash budgeting and cash flows management
Cash budget is an indispensable tool in managing cash flows. a
Wale fannagement Magnifies the inevitable relevance of budgeted
ws tor a year. This budget provides working details on when
ae than the need for the period and when is additional cash rod
mmanagomett® ed requirements for a given period. d “atl in
Nt pre-determi i
givenvenen €rmines the excess cash inflows an vl
ea ce budget gives a chance to management to prepare eye
ere to invest the excess cash while maintaining sufficient "4 Cash and Marketable Securities Management 930
i
gy future needs, and where to outsource additional cash for short-
sali nd working capital needs at the lowest possible cost of money.
1 ;
ee of the advantages of having an adequate cash and near-cash
are Nalee dey
increased savings from availed of suppliers’ trade discounts.
> Maintained credit rating. a Lips ono
5 Opportunity to take advantage of favorable business conditions.
the end of the day, the best cash management focuses in
ash collections and decelerating cash outflows.
assets
33!
33
33
stil.
gocelerating C
Cash receipts management and “deposit float”
cash inflows and outflows should be synchronized. Cash inflows should
be accelerated and cash outflows should be slowed down.
One major variable that affects the cash inflows and outflows is the cash
float Press a
Float means delay. It is the time interval from the check is issued to the
point the cash is transferred to the payee’s account. A float could either
be a collection float (I.e., seller's float) or a disbursement float (i.e.,
ouyers float). The collection float should be minimized while the payment
float should be maximized.
From the point where a customer issued a(check, the enterprise should
doall the necessary techniques to speed up the transfer of cash.
in the process of realizing checks issued by customers into cash, the
"enterprise has to manage a “check to cash conversion float’
421 A float consists of the following:
* Mail float. The time interval from the check is_issued to the
point the mail is received by the collecting party.
* Processing float) It is the time from the date the mail is
received to the point the check is deposited to the\ payee’s
account. | fd
* Clearing float (financial system float). It represents the normal
banking clearing time of checks. It is the time from the date of
deposit is made up to the date the cash is already available
The fal _for withdrawal. 5 :
ollowing techniques are used in accelerating cash receipts:
; High credit standards.
43 Efficient and effective billing system.
min ffective and efficient collection policies.
gaunimize the mail float, the following techniques may be used:
Lockbox system. Applied by renting mail boxes in the post office
‘0 quicken segregation and delivery of mails.
a
|REVIEW NOTES| 931
48
|REVIEW NOTES |
5.0
5.1
6.0
6.1
6.2
6.3
Cash and Marketable Securities Managemen,
442 Direct sends
To minimize the processing float the following may be
4.5.1 Wire transfer
45.2 ACH (Automatic clearing house) debit (ie, bank to bany
automatic debit) HN,
4.53 Electronic fund transfer (EFT)
45.4 Electronic fund transfer on point of sale (EFTOS)
45.5 Concentration banking
456 Preauthorized check (PAC)
45.7 Depository transfer check
4.6.1 To minimize the financial system float, deposit the Cole
before the cut-off time. Collect
Applied
Cash payments management and “disbursements float”
The following techniques are used to slow down cash releases
5.1.1 Controlled disbursements
5.1.2 Playing the float
© Use of draft.
+ Use of checks
Issuing crossed check.
Issuing check after the cut-off deposit time.
Issuing check only on Fridays.
Overdraft systems, zero-based accounts, and ACH crest
¢ Payroll management
5.1.3 Less frequent periodic payroll dates instead of dally W
payment or weekly wage payment
Temporary excess operating cash and short-term investments
What are temporary investments or marketable securities?
6.1.1 Marketable securities are highly liquid, short-term, interes!
money market placements or securities.
6.1.2 Marketable securities include cash equivalents, short
placements, financial assets held for trading, and simlat
instruments
Who issues marketable securities?
6.2.1 National government and government agencies
6.2.2 Private enterprises
Factors influencing the choice of marketable securities
6.3.1 Risk
eat
¢ Default risk >
Cash and Marketable Securities Management 932
r . Interest rate risk
Inflation risk
53 Maturity a
yield or return on securities
marketability (liquidity risk)
5 evel of short-term securities investment may be determined as
623
g24
lows
’ [quid funds needed Px
"Transactional cash balance aoe
cash safety stock PX = Transferable to short-term investments
cash deficit, borrowings, ard short-term financing
ifthe operating cash budget shows a potential cash deficit at any given
time during a budget period, an enterprise can immediately institute
remedial actions to prevent such deficit. To improve its projected cash
position and liquidity, the first thing an enterprise should do is to
streamline its operating cash inflows and (or) reduce operating expenses,
then, or unload non-performing long-term assets before borrowings as
sources of financing should be tapped. .
? Borrowings may be long-term or short-term. Short-term borrowings are
normally harnessed for working capital requirements. Short-term
borrowing may classified as spontaneous or non-spontaneous.
1 Spontaneous short-term financing is derived from the natural sources of
credit as defined by business practices. Examples are accounts payable,
accrued expenses, and revolving line of credit.
Non-spontaneous short-term financing requires extra effort on the part of
the borrower before the fund may be secured. Examples are single-line
and multiple-line bank: credits, factoring of accounts receivables,
discounting of notes receivables, inventory liens, issuance of commercial
ae and other short-term financial instruments.
tor-term financing may also be classified as secured or unsecured
al Examples of unsecured borrowings are trade credit and
eh 7 expenses. Examples of short-term financing are back-to-back
receiy loan, factoring of accounts receivable, pledging of accounts
ables, discounting of notes receivables, floating inventory liens, and
in
Yentory warehouse receipts.
Athi
bitrage Pricing Rate (APR)
Th j i
hayes is the effective interest rate and is computed on a periodic
’ Single annualized basis, and continuing annualized basis.
EE eS, ee ae
j
;
i
:
:
F
|REVIEW NOTES| [REVIEW NOTES |
a
nm
ow
ao
a
o
o
nN
~
Cash and Marketable Securities Management
Chap
slas in computing the different interest rates are:
"Net interest payments / N t proceeds _ fi
: inancing cost / Net proceeds”
arbitrage pricing rate (or effective interest rate)
compounded annual effective interest rate
n no of periods
ceriodic effective interest rate
cing costs include interest payments plus transaction costs 5
‘ocessing charges, regulatory fees, etc.) less income deriveg tt
ercial use of borrowings found to be temporarily idle
‘oceeds is the principal less discounted interests, loan Processin
's deducted in advance, and incremental compensating balance.
When the borrowing is expected to be continuous during the year, the
compounded annual effective interest rate (CAEIR) shall be:
CAEIR = [(1 + PEIR)" - 1]
llustration:
Say i
Principal amount of short-term borrowing _|_ P500,000
Nominal interest rate, discounted | 10%
Time period 2 months
No. of periods [42 months / 2 mos. 6
Analysis: Hae
E Annual Periodic
Interest paid P500,000 x 10% P50,000
Net proceeds P500,000 - 450,000
P50,000
APR___P50,000/P450,000 11.11% _|
PEIR 11.11% /6 1.8518%
CAEIR | [(1 + 0.018518)°- 1] z 13.71% J
Establishing desired cash balance
Establishing a desired cash balance may be done using the subject®
model, say, 10% of the following month's sales.
Quantitative model is used to compute the optimum cash balance, Cash and Marketable Sceutties Management an
the optimum cash balance
ideally. the optimum cash balance is zero.
requirements in business undertakings,
maintained :
Despite the prominence of cash balance in the management of working
capital. tt would be unwise for the enterprise not to determine the
optimum cash balance that would give it the lowest cost of carrying cash
and transacting in cash.
As aiscussed in the cash budgeting, excess cash is invested in temporary
investments, while a potential cash deficit may be managed by
streamlining operating activities or through borrowings.
if these activities and notions are considered, there appear to have two
cash costs, namely, the transaction costs and the carrying costs, and
there standard computations are as follows:
lowever, because of practical
cash balance should be
‘Transaction —_|_No. of transactions x Cost per transaction _
costs | (Total cash need:/ Transaction cash) x Cost per |
eee | transaction sree eeeeeaaeiaaa |
‘Carrying | Average cash balance x Cost of carrying cash _ |
costs _| (Cash balance/2)xCostofcarryingcash
Carrying cost is the opportunity lost in holding the cash and not being
used in an investment activity. It is also referred to as opportunity costs.
Transaction costs consist of the amounts paid to brokers, market
regulatory agencies, and government agencies in buying and selling
securities in the capital market.
Theoretically, a desired cash balance is the optimum cash balance where
the total relevant costs of cash would be at the minimum. The relevant
Costs of cash are its holding costs and opportunity costs. io
A desired cash balance may be established by using the subjective model
or the quantitative model. :
In ees model, the company sets the desired cash balance
based on a related factor. Let us say, the minimum cash balance is 10%
; Of the following month's sales.
* In the quantitative model, we have the Baumol model or the Miller-Orr
Mode|
' The Baumol Model
ie / (2 x Annual Demand x Cost per Transaction /
Carrying costs rate
0c
|REVIEW NOTES| |REVIEW NOTES|
oo”
935 Cash and Marketable Securities Management
Chae
oct = \/ (2x AD x CPT)/CCR :
where: —
OCT "| optimal cash amount to be transferred to and fo ~
transfer cash balance
AD | Annual demand refers to annual cash ©XCESS oF annag~
cash need a .
CPT Cost per those incurred in buying and selling —~
transaction commercial papers in the mone marke
CCR _| Carrying cost rate opportunity cost of holding cash
am _—————
10.11.1 Illustration
Say:
Annual cash need P40 milion
Cost per transaction P600
ROI on temporary investments 10%
Therefore:
692,820
OcB \/ (2x P40 M x P600) / 10%
Transaction costs (P40 M/ P692,820) x P600 34,641
Opportunity costs (P692,820 / 2) x 10% 34H!
Total cash costs Peg2e
* Average cash balance = OCT/ 2 : a
* In the use of this model, it is assumed that cash inflows
outflows are known with certainty. .
10.6 The Return Point Model (or the Miller-Orr Model)
poit
10.6.1 The formula for the optimal cash balance using the Retum
Model is as follows: _-
EM a 74 x Dall
RP = /(2 x Conversion Cost x Variances of Daily Net Cash Flows)
Opportunity Cost) ,
where:
Upper limit 3xRP
RP.
Return Point
Upper limit - RP
oun
Cash transferred to MS -
Cash and Marketable Securities Management 93h
MS converted to Cash = Return Point a
uu
406-2 Cash inflows and outflows are uncertain 5
1063 Cash balances fluctuate between the “upper limit” and “lower limit =
4064 Upper limit = 3 x Return Point 2
1065 Cash converted to marketable securities = Upper limit ~ Return >
Point @
1066 Marketable securities = Return Point .
Fi Net cash cycle (NCC)
40.7.1 Net cash cycle = Operating cycle — Payment period
40.7.2 The NCC is positive if the operating cycle is longer than the
payment period. The NCC is negative if the operating cycle is
shorter than the payment period.
40.7.3 A business should maintain a negative net cash cycle to maintain
liquidity in its operations
40.7.4 If, then, else, what to do
(hen ation ___|
Nonspontaneous Inventory ] Collection Payment
tt financing days | says : Ip [days]
Ws Positive |} ; | oe
NOC= Negative wv ® ® pv
ite Accounts payable = spontaneous financing (non-negotiated)
tong-term payables = non-spontaneous financing (negotiated) _
10.7.5 Say,
Case 1 Case 2
Inventory days 20 days 30 days
Collection period 30 days 40 days
Operation cycle 50 days 70 days
Payment period 60 days 50 days
Net cash cycle (10) daysF 20 days UF
Annual operating expenses P14.4M P14.4M
Cash short (excess)
[(P14.4 M/ 360) x 10] P(400,000)
[(P14.4 M/ 360) x 20] P800,000
12% 12%
Cost of capital
Opportunity costs (savings)
[P400,000 x 12%] P( 48,000) F [REVIEW NOTES |
11.0
Cash and Marketable Securities Management
{[P800,000 x 12%] P95 000
Nonspontaneous financing v n
Spontaneous financing ~ Vu
Marketable Securities
Marketable securities are highly liquid, short-term interes.
government and nongovernment money market instruments 7.
be easily converted to cash.
To be truly marketable, a security must have two bas
‘) a ready market and (2) a safety of principal (i.e, no
in value)
Risk and maturity influence the choice of marketable securities
1131 Risk
+ Default risk. The issuer may not be able to Pay the
the interest at due dates.
+ Interest rate risk. The decline in market values of the
due to rising interest rates.
+ Inflation risk. The future deterioration of the purchasing cov
of a currency
* Marketability or liquidity risk. The security may ret %
immediately sold or if sold is made at a substantal 9
concessions
11.3.2 Maturity. It should be aligned with the Projected working °2"
needs of the business. Convertibility of marketable secures ?
cash (€ , liquidity) is more important than yield on matuitty
Examples of marketable securities
1141 Marketable securities May be divided into two g/curs
government issues and (2) private corporation issues
1142 Examples of marketable securities are
IC characters.
ikelihoog
princial a
. ng |
Security Issuer Description Risk @
Government issues |
| e
ell g,_ National | Regularly issued at Lowest *
Pdey 60-day 91 Government | auction, sold at be
aay 182 day | discount, strong
Treasury notes
secondary market
National
government
| Low, sig™ ne
8
| Stated interest rate | aman te
| strong secondary ~~ |
Cash and Marketable Securities Management
ave '
ment i
won | a
neues | | IE
iable Commercial banks Represent specific Higher than 3
wea coat cash deposits in | government securities =
et os) Commercial banks; | issues and comparable ins
ep amount and tocommercial paper >
| esin 30 maturities tailored to jw
tut ts investment needs; Es
gays ate 4 ff large denominations; |
mon, wit | good secondary |
genominations In market |
milions of pesos |
commercial papers Corporation with a Unsecured note of | Higher than if
high credit rating issuer; large government securities |
vetuities denominations issues and comparable |
snyere from 3 to negotiable CDs
cays to 270 days
wth denominations
inmillions of pesos |
— Banks Results from a Slightly lower than |
Banker's guarantee of a negotiable CDs and
acceptances business commercial paper but
heer transactions; sold at | higher than |
discount from maturity | government securities
ain 30 days, 90 value issues |
days and 180 days |
|
Voney market Professional portfolio | Professionally | fe Pinel. |
Mutual funds management managed portfolios of | poner (han Fhulippine |
28 Ol | treasury issues and |
companies marketable securities; comparable to i
provide instant negotiable CDs and
liquidity commercial papers
Re
Mealiid Bank or secutity Bank or security Generally slightly
ee dealer sells specific | below that associated
dealer e
securities to firm and | with the outright
agrees to repurchase purchase of the
them at a specific security
price and time
buy
a deposits Deposits of currency Highest, due to less
not native in the regulations of
country in which the depository banks and |
bank is located; large | some foreign |
| denominations; active | exchange rate
| secondary market |
Foreign banks IREVIEW NOTES |
Cash and Marketable Securities Management th
939
12.0 Internal controls for cash
(the Iist is not intended to be all-inclusive!)
12.1 The cash department should be under the supervision of the treasure
12.2 The cash department should be separated from the accounting and ¢
departments that keep records of transactions and events.
All cash transactions must be supported by available proof of accur,
12.3
All cash receipts must be issued with prenumbered official Teceipts
check issuances must be supported by delivery receipts, sales inyoj,
receiving reports, board resolutions, or official receipts
All cash receipts must be deposited intact in the designated deposit
12.4
bank on the day of collection or in the following business day.
12.5 Bank deposit slips must always be on file, complete and available
12.6 Periodic reconciliation of bank and book records must be done.
12.7 Cash count should always be done and with an element of surprise
12.8 All checks must be properly signed and approved by at least two signatures
12.9 Cash personnel must be properly selected and trained
12.10 Cashiers must be bonded.
12.11 Cashiers should be rotated, periodically or surprisingly.
12.12 A cashier's manual must be made available.
12.13 Use mechanical or electronic equipment in issuing checks and official receipts
12.14 Preparation and verification of daily cash report.
STRAIGHT PROBLEMS
Optimum cash balance. Liquid Industries forecasts cash outlays of P48 million tors
next fiscal year. A financial analyst for the company has estimated the convers®
cost of converting marketable securities to cash to be P900 per converso”
transaction and the annual operating cost of holding cash instead of marketabe
securities to be 8%. Presently, the company converts cash to marketable secu’
and vice-versa on a monthly basis
1.
Required: Using the Baumol model, calculate the following:
a. The optimal cash conversion amount.
The average cash balance.
The number of conversion to be made during the year.
b
c
d. The total cash costs. el
e The net advantage if the company follows the optimal cash conversion mo * ie eee eee
|REVIEW NOTES|
Cash and Marketable Securities Manan: ment 940
aut "
_qiON GUIDE
na cash balance = V (2x an, a CPT)/CCR
a = \/ (2x P48 million x P900)/8% = P1,039,230
syerage cash balance = P1,039,230/2 = p519.615 .
b mber of conversions = P48 million / P1,039,230 = 46 18804 times
© transaction costs (46.18804 x P900) P 41.569
¢ opportunity costs (P519,615 x 8%) 41,569
Total cash costs P 83,138
transaction costs (12 x PS00) P 10,800
: Opportunity costs {(P48 million / 12 )/ 2] x 8%) 320,000
Total cash costs ~ monthly basis 330,800
. Total cash costs — optimal basis
7 — 83,139
Advantage of the optimal cash conversion model P247,661
Required: Calculate the following:
2 The retum point
The upper limit using the current values
2 SOLUTION GUIDE ——
a Return point = . / 2x Cost per transaction x Variance of daily net cash flows
4 x Daily opportunity cost
—__——_ Srerunity cost
= Ve x P50 x P2,000,000} / [4 x (.08/360)}
200 million / (4 x 0.000222)
474.580
+ _Yeperlimit = 3x Return Point = 3x P474,580 = P1,423,740
GHective interest rate. EIR Corporation wants to raise P5 million through short-term
“srowing. The company gathered data from several banks and financing institutions
‘Biassembledthefollowing oo
Lending institutions A B_ cb | |
Amount to be borrowed | P5M PEM P5M| P5M PSM]
Nominal interest rate 10% | 12% discounted | 11.5% | 14% | 15%,discounted |
‘nsating balance none 5% 4% none | 10% |
erage deposit | |
ee even if the none none | none | P200,000
Is not granted one tyr, |
Tem ofthe loan 1 yr. Lye Tye. Vye | y |
‘rest earned by the nla 6% 6% 6% | 6% |
“petsating Balance | | | | 2,
O41 Cash and Marketable Securities Management Ch
“Apter |
a Required: For each of the terms of the loan offered by the lending "NStitutio,
BL calculate the effective interest rate. ns,
oO 2 ey = _ - ———___
2/3. SOLUTION GUIDE
= A 8 Cc D
wu Interest payments P 500,000 P 600,000 P 575,000 P 700,000
S ~ Interest income from
if) compensating balance GO: 15000) 12000 418.000
in Net financing charges 500,000 585,000 563,000 "700,000 Trainee
| Principal 5,000,000 5,000,000 5,000,000 5,000,000 pq 002
| = Increase in compensating balance 0 (250,000) —( 200,000) 2 (300,009
| - Discounted interest 0 C0000) ao 750 900
| Net proceeds 5,000,000 4,150,000 4,800,000 —_5,000,000 3.950.009,
Effective interest rate —-10,00% 14.10% 11.73% 14.00% 7 igsay
| Interest payment = (Principal x Nominal interest rate) _
| Interest income from compensating balance = Increase in compensating balance x Interest rate
|___ Effective interest rate = Net financing charges / Net proceeds
7 - a
4. Effective interest rate, continuing basis. A local bank has just approved a 90-day,
P200,000, 12% per annum line of credit to VJ Company. VJ plans to regularly avail
of the credit line throughout the year. Determine the effective interest rate ona
continuing basis.
|4. SOLUTION GUIDE ]
| a. Effective interest rate = P24,000 / (P200,000 — P24,000) = 13.64%
b. No. of periods = 360 days/90 days =4
| c. Periodic effective interest rate = 13.64%/4 = 3.41%
| gd. Annual effective interest rate = [(1 + 0.0341)*—1] = 18.25%
5. Cash flows management.
a. Float. Tulips Company has daily cash receipts of P85,000. A recent analysis of
its collection indicated that customers’ payments were in the mail an average of
2.5 days. Once received, the payments are processed in 1.5 days. After
payments are deposited, it takes an average of three days for these receipts to
clear the banking system
Required:
1. How much collection float (in days) does the firm currently have?
2. If the firm’s opportunity cost is 11%, would it be economically advisable for the
firm to pay at an annual.fee of P16,500 to reduce collection float by four days:
——
5a. SOLUTION GUIDE
1. Cash collection float = Average daily collection’ x Total float in days
|
P85,000 x (2.5 days + 1.5 days + 3 days) |
P85,000 x 7 days
P595,000
2. Potential income (P85,000 x 4 x 11%) P37,400
- Annual cost of reducing the float 16,500
Net advantage of reducing the float by4days P20,900 Cash and Marketable Securities Management 942
n
wi
xbox system... A firm that has an opportunity cost of 9% is contemplating 5
$ to alation of a lockbox system at an annual cost of P90,000. The system is >
Tipected to reduce mailing time by 2.5 days and reduce clearing time by 1.5 2
ays. If the firm collects P300,000 per day, determine the net benefit (cost) of iit
installing the lockbox system. z
aw
@ SOLUTION GUIDE a
Benefit of using the lockbox system (P300,000 4 days x 9%) P108,000
- Cost of using the lockbox system 90,000
Net benefit of using the lockbox system P_18,000
¢ Concentration banking. Mills Corporation sells to national market and bills all
credit customers from the Makati office. Using a continuous billing System, the
frm has collection of P1.2 million per day. Under consideration is a
concentration banking system that would require customers to mail payments to
the nearest regional office to be deposited in local banks.
Mills estimates that the collection period for accounts will be shortened by an
average of 2.5 days under this system. The firm also estimates that annual
sevice charges and administrative costs of P300,000 will result from the
Proposed system. The firm can earn 14% on equal-risk investments.
Required:
1 How much cash will be made available for other uses if the firm accepts the
Proposed concentration banking system?
fe at Savings will the firm realize on the 2.5-day reduction in the collection
TIO
The net benefit (cost) of the concentration banking.
E es e
LUTION GUIDE |
| ‘ash made available using the concentration banking
Sa = P1.2 million x 2.5 days = P3 millon
“3¥ings from teducing the collection days (P3 million x P14%) = P420,000
L 3, Net nt! Service charge from using the concentration banking 300,000
“———2tefit of using the concentration banking P120,000
1
* Dire
Pata on! South Star Corporation just received a check in the amount of
"omal om a customer in Baguio. If the firm processes the check in the
Morass mer, the funds will become available in 7 days lo speed up the
heck i es firm could send an employee to the bank in Baguio on which the
me ayn to present it for payment. Such action will cause the funds to
San Sarn, tapable after 3 days. If the cost of the direct send is P800 and the firm
%* on these funds, calculate the net benefit (cost) of this system.
~ j|REVIEW NOTES]
943
Cash and Marketable Se
Sd. SOLUTION GUIDE
curitics Management |
Napter |
Benefit from accelerating collection (P800,000 x 4/365 days x 11%) P 964
- Cost of accelerating collection through direct sends 800
Net benefit from using the direct send
e. Controlled disbursing. A large Bulacan firm has annual cash disbur.
P360 million made continuously ove
administrative costs would increase by P100,000, the firm is consid
all disbursement checks on a small bank in Pangasinan. The firm e:
this will allow an additional 1.5 days of cash usage. If the firm earn
system i P 164
Sements of
Service ang
ering wtin,
stimates, that
r the year. Although annual
IS @ return on
other equally risky investment of 12%, determine the net advantage
(disadvantage) of using this technique of cash disbursement. .
Se. SOLUTION GUIDE
Benefit from delaying payment (P360 million/360 days x 1.5 days x 11%) P 165. 000
- Cost of delaying payment
f. Playing the float. Marikina Corporati
cover all checks when written. A tl
100,000)
Net benefit of delaying payment through controlled disbursing PB. 65,000)
ion routinely funds its checking account to
horough analysis of its checking account
discloses that the firm could maintain an average account balance that is 25%
below the current level and adequatel
account balance is currently P900,001
ly cover all checks presented. The average
0. If the firm can earn 10% of short-term
investments, what, if any, annual savings would result from maintaining the lower
average account balance.
[5f SOLUTION GUIDE ;
Annual savings (P900,000 x 25% x 10%) P22,500
g Payroll account Management. Toys,
transfers the same a
Inc., has a weekly payroll of P250,000 and
mount to the payroll account on the payroll date. The payroll
checks are issued on Friday afternoon each week.
cashing behavior of its employees, it has found the follo
In examining the check-
wing pattern:
Business days from Percentage of
issue of check checks cleared
1 20%
2 40
3 30
4 10
Business days do not include Satu
investments earn 12% per year.
funds its payroll account based on the
How much savings would the firm general
short-ter"”
days and Sundays. Average stores iftt
9
employee check-cashing behavior
- Cash and Marketable Securities Management one
-—goLUTION GUIDE
60 savings from controlled transfer of payroll fund
(P250,000 x 20% x 1/360 x 52 wks. x 12%)
(P250,000 x 40% x-2/360 x 52 wks. x 12%)
(P250,000 x 30% x 3/360 x 52 wks. x.12%)
(P250,000 x 10% x 4/360 x 52 wks. x 12%)
Total savings from controlled transfer of payroll fund
Le
h Zero-balance accou
nt. Rita Company is considering the establishment of a Zero-
balance account. The firm currently maintains an average cash balance of
420,000 in its disbursement account which does not earn interest. AS
compensation to the bank for maintaining the zero-account balance, the firm will
have to pay 4 monthly fee of P1,000 and maintain a P300,000 non-interest-
earning deposits in the bank. The firm currently has other deposits in the bank
and can earn 12% on short-term investments. Evaluate the proposed zero-
account balance. -
sh SOLUTION GUIDE
interest income from released cash (P120,000 x 12%) P14,400
- Cost of maintaining a zero-balance account (P1,000 x 12) 12,000
0.
Net benefit of maintaining a zero-balance account
2 Cost of issuing the commercial paper. Carmelo, Inc., will need P4 million over the
next year to finance its short-term requirements. The company Is considering
fnancing alternatives - ban'’ financing and the sale of commercial paper.
Tatac Union Bank is willing to loan Carmelo the necessary funds providing the
company maintains a 20% compensating balance. The effective cost of the bank
‘ean, considering the compensating balance requirement, is 10.4 percent on a
Pretax basis.
bal the other alternative Carmelo would sell P4 million of 90-day maturity
a Paper every 3 months. The commercial paper will carry a rate of
ne interest rate is expected to remain, at this level throughout the year.
of ter ape paper dealer's fee to place the issue would be a one-time charge
Compa @ commercial paper dealer will require Carmelo to establish a P400,000
‘Nsating balance.
Man;
fi ae prefers the flexibility of bank financing. However, if the cost of bank
mele pias exceed the cost of the commercial paper by more than 1 percent,
ued Ins to issue the commercial paper.
Mey Uno, Calculate the effective cost of selling the commercial paper and based
Ihe. n your cost calculation, recommend the method of financing Carmelo,
select (ema)
|REVIEW NOTES| 945
Cash and Marketable Securities Management
[REVIEW NOTES |
SOLUTION GUIDE:
Interest expense ( P4 million x 7.75%)
Dealer's fee (P4 million x 0.00125)
Total cost of selling commercial papers
Divided by net proceeds:
Face value
- Compensating balance
Effective cost of the commercial Papers
Effective cost of bank financing
Itis advisable for Carmelo to use the
1.67% in effective interest rate.
_
P 310,000
5,000
315,000
P 4,000,000
400,000 3,600,000
———_ 8.78%
%
commercial paper financing and save
ee Cash and Marketable Securities Management o
MULTIPLE CHOICE QUESTIONS
management
fow f the following actions would not be consistent with good management?
erased synchronization of cash flows
i
| A minimize the USE of float.
iF Maintaining an average cash balance equal to that required as a compensating
balance or that which minimizes total cost.
5 Use of checks and drafts in disbursing funds (rpcpa)
spe one which is not consistent with good management.
Cash management deals with balancing the cash inflows of the business with that of
‘5 cash outflows. In periods where additional cash is needed, the sources of
‘racing must be identified and activated. In periods of excessive cash, the viable
sestments must be tapped. The following are indicative of good cash management:
= Maintaining an optimum cash balance that minimizes the total cost of cash or
maintaining a minimum cash balance that equals the required compensating
balance.
» Speed-up cash collections
+ Effective credit standards, analysis and approval.
Effective collection policies such as use of mailbox, pick up points,
electronic fund transfer, concentration banking, and updated and
accurate billing system.
* Delay cash payments
Use of drafts
Use of checks for better internal control and to maximize float
Use of TGIF (Thank God, Its Friday) policy in the issuance of checks.
Bill first, before payment policy.
_froierletter “a’, “c” and “d" are all good cash management policies. Choice-
“0 minimizing the use of payment float, is not a good cash payment policy
_.<* of the following investments is not likely to be a proper investment for
Paty idle cash?
eo Public offering of an established profitable conglomerate
mercial
Tee Paper.
S Su
2 Te SU bills,
16
@ury bonds due within one year. (rpepa)
ie
tegen 'S not likely to be a proper investment in temporary idle cash
™~ Contrib Cash ought to be used (or invested) somewhere to give a faw return
ty ary, eS 'N increasing the common equity of the firm It the excess cash is
berms, Place it in temporary investments _ If the excess cash Is permanent, place
Nt investments, |MULTIPLE CHOICE|
Ow
a
~
b
Maher
Cash and Marketable Securities Management
Temporary investments are those expected to be converteg i
notice. Examples of temporary investments are short-term ti
notes, Philippine Treasury Bills, negotiable instruments,
commercial papers, and those in the securities but are rea
temporary investments in shares of stocks and bonds).
Initial public offering (IPO) of an established conglomerate, ¢,
and treasury bills are examples of temporary investments.
one year, are not temporary in nature (e.g., one year)
investments are in bonds (where the bond market is not
financial markets) and that bonds are in treasury. Hence, choi
nto Cag)
= Aeposits, bron, Shag
" Other gy S80,
dily Marketable oe
as
Hin
Merciaj
ple ban
iret fact that a
active in Phi the
ice-letter “q” jg conent®
A precautionary motive for holding excess cash is
A. To enable a company to meet the cash dem
business activity.
B_ To enable a company to avail itself of a si
rise to higher levels
C. To enable a company to have cash to meet emergencies that may ati
periodically We
D. To avoid having to use the various t
cover projected cash deficits
lands from the AOMMAl flay ¢
pecial inventory purchase before pric
lypes of lending arrangements available to
(rpcpa)
Cc
A precautionary motive for holding cash.
Under normal conditions, there are three (3)
or emergencies where e:
the company to stay ahead in competition by intellectually predicting business trends
(2.g., buying more inventory before Prices increases in times of recession, also cal!
as black-marketing)
Choice-letter “c” is the c
cash. Choice-letter “a”
motive. Choice-letter
he correct answer, it refers to precautionary motive of holding
's a transactional motive. Choice-letter “b" is a speculati?
“d" relates to prudent cash Planning and management.
The following practices will
1. Sales personnel are un
2. Sales commissions are
3. Statement of accounts
sent for confirmation.
4. Automatic transfer of f
branches
Of the above, which will result
A. All statements.
B. Statements 1, 3, and 4 only.
impact the cash flow of the company:
lequivocally responsible for collecting their credit sales
based on collected invoices. ula
receivable are reconciled with customers and rea!
so
lunds is arranged with banks regarding depos!
It to better cash flow?
C. Statements 3 and 4 only (coc)
D. Statement 4 only
—_ ao er cash flows
® statements 4
Cash and Marketable Securities Management 948
ractice(S) that results to better cash flows
“etter “C” IS correct. The practices mentioned in statements 3 and 4 refer to
ion policies Reconciliation and confirmation of accounts with customers “and
tic transfer of funds regarding bank deposits of branches are meant to result
tt and 2 will result to weak cash flow controls since sales are
tions while collection of credit sales is a custodianship (e g , treasurer's
erating func
ynction) Combining these two functional responsibilities into the hand of a person
ish the effectiveness of internal control, and therefore, will not result to
ul
id dimin!
better cash flows.
: compensating balance ;
a compensates a financial institution for services rendered by providing it with
deposits of funds. ;
g. Isused to compensate for possible losses on a marketable securities portfolio
¢ isa level of inventory held to compensate for variations in usage rate and lead-
time
p isthe amount of prepaid interest on a loan. (cma)
5A
7 Astatement about compensating balance.
institutions to be
Py compensating bal
maintained or deposit
borrowed. Choice-letter “a” is correc’
the effective borrowing rate by reducin:
Choice-letter "b” is incorrect because a Co!
borrowings and
ssincorrect because it refers to safe
lance is normally required by financing
ited by the borrower as his equity contribution on the amount
. Effectively, a compensating balance increases
g the net proceeds of the amount borrowed.
mpensating balance is used for cash
not for marketable securities portfolio transactions. Choice-letter “c”
sty stock. Choice-letter “d” is incorrect because it
tefers to discounted interest on the loan.
# Anautomated clearing house (ACH) electronic tr
A Electronic payment to a company’s account ai
8 Check that must be immediate!
© Computer-generated deposit ticket veri
D Check 'like instrument drawn against the paye'
A
2geseipton about automated clearing house (
a is transfer (or electronic fund trans
coll account to another using electron'
lecting companies to expedite coll
an
Mstity
lutions Choice-letter “a” is correct.
8 not
ansfer is a(an)
t a concentration bank.
ly cleared by the Bangko Sentral ng Pilipinas.
ifying deposit of funds.
rand not against the bank.
ACH) electronic transfer.
fer or EFT) is a movement of cash balance
ics technology. This is normally harnessed
lections from customers, near or far, by
Ss of electronic fund transfer services offered by banks and other financing
pcedetter “b" is incorrect because it refers to outstanding checks, and a check
Involved in EFT. Choice-letter “c’ is incorrect because it relates to deposits
|MULTIPLE CHOICE| |MULTIPLE CHOICE|
—
949 Cash and Marketable Securities Management Chapter 17
from various sources and not transfer of funds from specific customers Choice-tette,
“d" is incorrect because an EFT is not a check-like instrument
7. A working capital technique that increases the payable float and therefore delays the
outflow of cash is
A. Concentration banking. C. Electronic data interchange (EDI).
B. Adraft. D. A lockbox system. (cma)
7. B
2 Aworking capital technique that increases the payable float and delays the outflow of
cash.
2 Float refers to the period of time a check or a draft is cleared through the banking
system. A draft is a 3-party instrument in which a drawer orders the drawee to pay
the money to the payee, and is a means of slowing cash outflows. It normally takes
an extra day to clear a draft than a check. Hence, choice-letter “b” is correct.
Choice-letters “a” and “d” are incorrect because concentration banking and
lockbox system are means of accelerating cash inflows. Choice-letter “c” is incorrect
because an EDI is an electronic technique used by suppliers and customers to
facilitate faster delivery of quality materials.
8. Which one of the following is not a characteristic of a negotiable certificate of
deposit? Negotiable certificates of deposit
A. Have a secondary market for investors.
B. Are regulated by the Bangko Sentral ng Pilipinas.
C. Are usually sold in denominations of a minimum of P100,000.
D. Have yields considerably greater than bankers’ acceptances and commercial
paper. (cma)
8. D
The description that is not a characteristic of negotiable certificate of deposit.
© A certificate of deposit (CD) is a form of savings deposit that cannot be withdrawn
before its maturity without incurring a higher penalty. Sometimes, it is called as tne
certificate of time deposit. Other CDs may be traded, hence they are called as
negotiable certificate of deposit. This form of temporary investment is less risky than
that of commercial paper and bankers’ acceptances, and therefore yields a lower, not
higher, rate. Choice-letter “d" is correct. ‘i
Choice-letters ‘a’, “b", and c” are incorrect because negotiable cettificate of
deposits are negotiable and therefore have secondary market, regulated by BSP
since they are channeled through the banking sector, and are usually sold with
minimum denominations
9. The most direct way to prepare a cash budget for a manufacturing firm is to include
A. Projected sales, credit terms, and net invoice.
B. Projected net income, depreciation and goodwill amortization.
C. Projected purchases, percentages of purchases paid, and net income. Cash and Marketable Securities Management 950
chapter ui
projected sales and purchases, percentages of collections, and terms of
payments. (cma)
D e items included in the direct way of preparing cash budget.
7 cash budget is the financial plan regarding cash inflows and outflows of a firm in a
| o riod. A cash budget prepared on a direct way itemizes cash receipts and
qisbursements. The more visible components of a cash budget prepared on a direct
way are collections - from customers and payments to merchandise suppliers,
salaries, and other important Operating expenses. As such, choice-letter “d” 1s
Budgeted collections from customers are coming from projected sales while
budgeted payments to suppliers originate from purchases.
Choice-letter “a” is incorrect because it does not include cash payments. Choice-
letter “b” is incorrect because depreciation and goodwill amortizations are added
back to net income in computing the net cash flows from operations using the indirect
method of cash flows presentation. Choice-letter “c” is incorrect because it does not
include sources of cash receipts.
Given the following events, which affect cash flows from operations?
1. Cash sale
2. Cash dividends paid
3. Purchase of a long-term asset
4. Purchase of inventory
5. Paid employees
i 2and 5.
1 4and 5. (rpcpa)
eo
»
o
3
a
a
oa
1 The transactions that affect cash flows from operations.
‘Q Choice-letter “a “is correct; cash sale is a cash inflow from operations and payment
‘oemployees is a cash outflow to operations.
tem no. 2, payment of cash dividend, is a financing activity. Item no. 3 does not
Specify whether the purchase is cash or non-cash and if ever purchased on cash is to
be classified as an investing activity. Item no. 4 does not mention whether the
Purchase of inventory is on cash, hence, assumed to have been made on account
: Yea Corporation had income before taxes of P60,000 for the year 2006 Included in
's amount was depreciation of P5,000, a charge of P6,000 for the amortization of
discounts, and P4,000 for interest expense. The estimated cash flow for the
Is
§ °80,000 C. P49,000
68,000 D. P71,000 (cma)
i
7
The
Sstimated cash flow for the period.
|MULTIPLE CHOICE| |MULTIPLE CHOICE|
951
Q
12.
13.
BYS
ee
Cash and Marketable Securities Management co
ter
The cash flow from operations may be computed using the indirect me!
flow presentation, as follows:
Income before income taxes P60,000
+ Non-cash items:
Depreciation expense 5,000
Bond discounts amortization 6,000
Net cash inflow from operations P71,000
The income before income taxes automatically becomes the net inco,
there is no applicable tax rate given.
thd ot cap
ME because
Bing and Bong’s Store is on the cash basis of preparing it funds stat
EMENt. These
data are available:
Decrease in working capital P50,000
Depreciation 13,000
Increase in cash 25,000
Repairs and maintenance 19,500
Total uses of cash 454,000
Calculate the total sources of cash of Bing and Bong's Store
A. P472,500 C. P479,000
B. P492,000 D. P467,000
c
The total sources of cash.
The total use of cash is
the data given in the
below:
(rpcpa)
given together with the increase in cash balance. Based or
problem, the total sources of ash is P479,000, as determinet
Total uses of cash P454,000
Add: Increase in cash 25,000
Total sources of cash P479.000
Better still, if the cash balance
beginning is given. The total sources of cash s"8
then be cash bal: 7 oe
lance beginning plus total uses of cash.
Shown below is a forecast of sales fol
T Carlos Inc, for the first four months of 2008 3
amounts are in thousand of Pesos).
2006
Cash sales me ae roa Pd
Sales on credit 100 120 90 70
ane eee sales are paid for in the month of sale, 30% in a
petite ga ea Mainder is paid 2 months after the month ©
lebts, t! 5 > March's
A. P138,000 he expected cash inflow for Carlos in
2.000 C P119.000 nal
2 D. P108,000 (or
a Cash and Marketable Securities Management
xpected cash inflows in March 2006.
[ credit sales collection pattern is 50-30-20, which means that March credit sales
Tre Gon will come from January sales (20%), February sales (30%), and March
co (50%), 28 follows:
se sgliections from credit sales:
January sales (P100,000 x 20%) P 20,000
February sales (P120,000 x 30%) 36,000
,
March sales (P90,000 x 50%) 45,000
Cash sales 18,000
Cash inflows in March 2006 P119,000
assume that each day a company writes and received checks totaling P10,000_ If it
takes 5 days for the checks to clear and be deducted from the company’s account,
and only 4 days for the deposits to clear, what is the float?
& P10,000 C. P(10,000)
ap O D. P50,000 (cma)
A
The amount of the float.
) The float referred here is the net float. A float is a time spent between the day the
check is written until the day the check is withdrawable or the deposit is cleared The
net float refers to the difference of the check float and the deposit float, as follows
Check float (P10,000 x 5 days) P50,000
Deposit float (P10,000 x 4 days) 40,000)
Net float (P10,000 x 1 day) P10,000
t
Deposit float is sometimes referred to as “availability float” while the check float is
aso called as “disbursement float’
Butt is a newly established janitorial firm, and the owner is deciding what type of
checking account to open. Butit is planning to keep a P500 minimum balance in the
acount for emergencies and plans to write roughly 80 checks per month. The bank
cherges P10 per month plus P0.10 per check charge for a standard business
ecking account with no minimum balance. Butit also has the option of a premium
business balance that requires a P2,500 minimum balance but has no monthly fees
slag check charges. If Butit's cost of funds Is 10%, which account should Butit
Shoose’
A Standard account, because the savings is P34 per year.
ue account, because the savings is P34 per year.
ndard account because the savings is P16 per year.
emium account because the savings is P16 per year
Coo
wav
(cma)
%
he
checking account that should be chosen
a
|MULTIPLE CHOICE| .
. 2? Adisadvantage using EDI in dealing with a supplier.
|MULTIPLE-CHOICE}. +,
=
GODyY
_.
Ch
hey
Cash and Marketable Sccurities Management
The checking account to be maintained should give the lower
checking account facility, as follows:
Cost of using a standard checking account
Bank charges [P10 + (80 x P0.10) x 12 mos] P216 00
Cost of funds (P500 x 10%) 50.00 P265 9)
Cost of using premium checking account (P2,500 x 10%) 250 09
Advantage of using the premium checking account P t60¢
Globe Products has received proposals from several banks to estabjish 8 lock
system to speed up receipts. Globe receives an average of 700 checxs : =
averaging P1,800 each, and its cost of short-term funds is 7% per year Assim!
that all proposals will produce equivalent processing results and using a oat
year, which one of the following proposals is optimal for Globe? te)
A PO.50 per check.
A flat fee of P125,000 per year.
A fee of 0.03% of the amount collected.
A compensating balance of P4,750,000.
OSt Of 9),
a»
4 hy
D
The optimal proposal received from several banks.
3 The business receives 700 checks per day, an average of P1,800 a day, and a cost
of funds of 7% per year. The costs of the several proposals are:
Cost of proposals
a. P0.50 per check (700 checks x P0.50 x 360 days) P126,000
b. Flat fee 125,000
c. 0.03% of amount collected
(P1,800 x 700 checks x 360 days x 0,03%) 136,080
d. Compensating balance (P1,750,000 x T%) 122,500 (lowest)
Proposal “d”, maintaining a compensating balance of 1,750,000 would only co:
business P122,500, and has the lowest cost among the proposals submitted 2°
therefore is the most desirable and optimal proposal.
Franklin, Inc., is a medium-size manufacturer of toys that makes 25% of its saes®
Mel Company, a major national discount retailing firm. Mel will be requiring ie
and other suppliers to use Electronic Data Interchange (EDI) for iv
replenishment and trade payments transactions as opposed to the pape"
systems previously used.
advantages using EDI in its d
A. Access to Mel's inventory balances of Franklin's products.
B. Better status of deliveries and Payments.
C. Compatibility with Franklin's of
‘ ther procedures and systems
D. Reduction in the payment float.
oy
x
Franklin would consider all of the following ©
lealings with Mel except
ona)
yom
17.D |
