chapter 9 cash collection systems. the cash flow timeline order order sale payment sent cash placed...

Chapter 9Cash Collection Systems

The Cash Flow Timeline

OrderOrder Order Order Sale Sale Payment Sent Cash Payment Sent Cash PlacedPlaced Received Received Received Received Accounts Accounts CollectionCollection < Inventory > < Receivable > < < Inventory > < Receivable > < Float Float > >

Time ==>Time ==> Accounts Disbursement Accounts Disbursement

< Payable > < Float >< Payable > < Float > Invoice Received Payment Sent Cash DisbursedInvoice Received Payment Sent Cash Disbursed

OrderOrder Order Order Sale Sale Payment Sent Cash Payment Sent Cash PlacedPlaced Received Received Received Received Accounts Accounts CollectionCollection < Inventory > < Receivable > < < Inventory > < Receivable > < Float Float > >

Time ==>Time ==> Accounts Disbursement Accounts Disbursement

< Payable > < Float >< Payable > < Float > Invoice Received Payment Sent Cash DisbursedInvoice Received Payment Sent Cash Disbursed

Learning Objectives

To understand the various options firms have to collect customer payments.

To differentiate between the various collection system and choose that system best suited for the company.

To collect the basic data necessary for a lockbox study.

To understand how a lockbox model works.

The Cash Flow Timeline for Collection Float

CheckCheck CheckCheck Check Check Good Funds Good FundsMailedMailed Received Received Deposited Deposited Received Received

TimeTime => => MailMail Processing Processing Availability Availability FloatFloat Float Float Float Float

Collection FloatCollection Float

Collection Float Collection floatCollection float is the time interval between mailing of the

check and the date at which cash is made available at the depositor’s account.

Mail floatMail float is the time that elapses from the point when check is written until it is received by the payee. Mail ranges from 1 day for local checks to 10 days for international checks

Processing FloatProcessing Float is the period of time extending from receipt of check until it is deposited in the payee’s account. Small companies, governments and non profits have normally higher processing float. It ranges from few hours to one or more days.

The other name for “clearing delay” is known as Availability FloatAvailability Float. It can range from immediately to as much as five days if weekends are involved.

Dollar Day Float & Annual Cost of Float

Dollar Day FloatDollar Day Float is a popular concept used to calculate the cost of float; it incorporates both the length of the float and the dollar amount involved. It is calculated by multiplying the individual remittances with the corresponding collection float

Average Daily Dollar Day Float is calculated by dividing the aggregate dollar day float by the number of days in a month

Annual cost of float is the total dollar value the firm is losing because of the collection float.

Cost of Float

Remittances x Collection Float = Dollar-Day FloatRemittances x Collection Float = Dollar-Day Float$ 50,000$ 50,000 2 2 $ 100,000 $ 100,000 1,200,0001,200,000 5 5 6,000,000 6,000,000 500,000500,000 7 7 3,500,000 3,500,000

1,0001,000 10 10 10,000 10,000-------------------------- ------------- -------------$1,751,000$1,751,000 $9,610,000 $9,610,000

Average Dollar-Day Float = Dollar-Day Float/Days in monthAverage Dollar-Day Float = Dollar-Day Float/Days in month =$9,610,000/30=$ 320,333.33=$9,610,000/30=$ 320,333.33

Average Collection Float = Dollar-Day Float/ RemittancesAverage Collection Float = Dollar-Day Float/ Remittances =$9,610,000/$1,751,000=5.49 days=$9,610,000/$1,751,000=5.49 days

Annual Cost of Float = Average Dollar-Day Float x RateAnnual Cost of Float = Average Dollar-Day Float x Rate =$320,333.33*.08=$25,626.67 [Assume, Rate= 8%]=$320,333.33*.08=$25,626.67 [Assume, Rate= 8%]

Types of Collection Systems

Company processing centersCompany processing centers- - Management may decide to process and deposit its own checks referred to as company processing center. The competing types of company processing centers include decentralized and centralized processing system.

Lockbox systemsLockbox systems

Company Processing Centers

Deciding which to use depends primarily on the volume of the checks processed and the dollar size of the checks.

Decentralized collection systems

With a decentralized collection system various field officers or collection end points receive payments directly from the customers.

Mail delay and Availability delay is minimal whereas processing delay tends to be longer

Centralized collection systems

Corporate headquarters receives all customer remittance

Quick processing system thus less processing float. More control over the funds.

Mail float and Availability float is normally higher.

Collection system Cost Factors

Company Processing Centers

Common data Decentralized Centralized

N 1,000

F $1,500

D 7 6

i 0.10/365

VC $0.25 $0.20

FC $100 $600

Company Processing Centers

Total cost (Decentralized)

= $1,000 x [($1,500 x 7 x 0.10/365) + $0.25] + $100

= $3,226.71

Total cost (Centralized)

= $1,000 x [($1,500 x 6 x 0.10/365) + $0.20] + $600

= $3,265.75

Lockbox Collection Systems A lockbox collection system is a blend of the two

company processing system with exception of that a bank or a third party handles the processing. A lock box system consist of dispersed collection sites,

similar to the decentralized company processing centers and it resembles a centralized collection system in that deposited funds are transferred on a frequent basis from the lockbox collection sites to the corporate head quarters.

Retail

Large volume of standardized invoice materials where checks have low average face value

Wholesale

Smaller volume with non standardized remittance information and larger dollar amounts

Cost Factors,TC = N x [(F x D x i/365) + VC] + FC

Lockbox cost analysis

Common data Citibank Chase

N 1,000

F $1,500$1,500

D 6 5

i 0.10/365

VC $0.45 $0.50

FC $225 $275

Lockbox cost analysis

Total cost (Citibank)

= 1,000 x [($1,500 x 6 x 0.10/365) + $0.45] + $225

= $3,140.75

Total cost (Chase)

= 1,000 x [($1,500 x 5 x 0.10/365) + $0.50] + $275

= $2,829.79

Lockbox cost analysis

Common data Citibank Chase

N 100,000

F $15$15

D 6 5

i 0.10/365

VC $0.45$0.50

FC $225 $275

Lockbox cost analysis

Total cost (Citibank)

= $47,690.75

Total cost (Chase)

= $52,329.79

Lockbox Location Study

Customer groups

Best approach when customer group is relatively smaller

Remittance sample

The sample should reflect the size of the company

Should incorporate the largest dollar values

Mail availability schedule

The Lockbox Optimization Model

The model determines the number of lockboxes that will minimize total cost. In addition the model provides the optimal lockbox locations and allocates the among the selected lockbox sites.

Complete enumeration is a popular technique used to optimize the number and use of lockbox sites, which will ultimately maximize shareholder wealth.