Imagine that GMI receives a check from a customer for $100,000. Assume, as before, that the company has $100,000 deposited at its bank and has a neutral float position. It deposits the check and increases its book cash by $100,000 on November 8. However, the cash is not available to GMI until its bank has presented the check to the customer's bank and received $100,000 on, say, November 15. In the meantime, the cash position at GMI will reflect a collection float of $100,000.

Position Prior to November 8:

Float = Firm's bank cash — Firm's book cash = $100,000 — $100,000 =0

Position from November 8 through November 14:

Collection float = Firm's bank cash — Firm's book cash = $100,000 — $200,000 = —$100,000

Checks received by the firm represent collection float, which increases book cash immediately but does not immediately change bank cash. The firm is helped by disbursement float and is hurt by collection float. The sum of disbursement float and collection float is net float.

A firm should be more concerned with net float and bank cash than with book cash. If a financial manager knows that a check will not clear for several days, he or she will be able to keep a lower cash balance at the bank than might be true otherwise. Good float management can generate a great deal of money. For example, the average daily sales of Exxon are about $248 million. If Exxon speeds up the collection process or slows down the disbursement process by one day, it frees up $248 million, which can be invested in marketable securities. With an interest rate of 10 percent, this represents overnight interest of approximately $68,000 [($248 million/365) X 0.10].

Float management involves controlling the collection and disbursement of cash. The objective in cash collection is to reduce the lag between the time customers pay their bills and the time the checks are collected. The objective in cash disbursement is to slow down payments, thereby increasing the time between when checks are written and when checks are presented. In other words, collect early and pay late. Of course, to the extent that the firm succeeds in doing this, the customers and suppliers lose money, and the trade-off is the effect on the firm's relationship with them.

Ross-Westerfield-Jaffe: I VII. Financial Planning and I 28. Cash Management I I 1 The McGraw-Hill

Corporate Finance, Sixth Short-Term Finance Companies, 2002


Chapter 28 Cash Management 781

Collection float can be broken down into three parts: mail float, in-house processing float, and availability float:

1. Mail Float is the part of the collection and disbursement process where checks are trapped in the postal system.

2. In-House Processing Float is the time it takes the receiver of a check to process the payment and deposit it in a bank for collection.

3. Availability Float refers to the time required to clear a check through the banking system. The clearing process takes place using the Federal Reserve check collection service, using correspondent banks, or using local clearinghouses.

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