csh mgt nw mdfd
TRANSCRIPT
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DIMENSIONS OF CASH FLOWMANAGEMENT
Prof. N. C. Kar
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Management of Cash
2
Cash includes hard currency, bank balances and
marketable securities.
Cash is the fastest moving asset of the firm.
Financial asset used for both operating & non-operating purposes.
Earns nothing when held in its form.
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Objectives of Cash Mgt. To maintain a cash balance that provides sufficient
liquidity to meet obligations.
To avoid maintaining idle cash as it has an opportunitycost.
Transactions Motive : Meeting day to daytransactional needs.
Precautionary Motive : Meeting Contigencies.
Speculative Motive : To take advantage of thefavorable market conditions.
Compensating Balance : To get various bank services.
3
Motives for holding Cash.
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CASH BALANCE VS CASH FLOWS.
Cash Balance is a static concept : the resultant of cash
inflows and outflows.
Cash flow is the movement of cash into, within and out
of the firm.
Management of cash basically refers to Planning,Managing & Controlling Cash Flows.
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TYPES OF CASH FLOWS.
Cash flows can be short cycle cash flows & long cycle
cash flows. Short cycle cash flows takes a short route to return as
against long route for long cycle cash flows.
Cash flows can be classified as operating & non-
operating. Operating cash flows are inflows & outflows resulting
from all operating transactions, i.e. sales, purchase ofinputs.
Office & administrative expeneces etc. Non-operating cash flows are classified into :
Investment flows
Financing flows
Other flows 5
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Cash Flow Vs Funds Flow.
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Investment flows : Capital expenditure and sale of variousinvestment
Financing flows : Issue of shares/debentures &
repayment of loans, payment of dividendand interest
Other flows : Un-common inflows and out-flows
While operating cash flows show random fluctuations, non-operating cash flows are fairly certain in timing and
magnitude.
Funds flow vs cash flow.
Power and cash flow statement.
Cash flow statement example.
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Short Term & Long Term Cash Flow Cycles.
The quantum of cash flow involved is much bigger than thatof short term cash flow cycle.
It covers normally fixed assets and long term liabilities.
* The orbital time is much longer than that of short termcash flow.* It is less volatile.
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Cash
Investment
Fixed Assets
Equity
Loans
Purchase
Sales
Labour&
Overheads
Stock
W/C
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Funds Flow Vs Cash Flow.Sales 10,00,000
Less COGS 6,00,000
EBIT 4,00,000
Less INT 80,000
PBT 3,20,000
Less Tax 1,60,000PAT 1,60,000
Depreciation (part of COGS) - 1,00,000
Fund From Operation 2,60,000
Assume 50 % Credit Sales not realized.
All other cost incurred in cash terms excludingdepreciation.
Continues . . . 8
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Cash Sales 5,00,000
Credit Realised - ----------
Less Cash COGS 5,00,000Cash EBIT 0
Less INT 80,000
Cash PBT - 80,000
Less Tax 1,60,000Cash PAT -2,40,000
CASH FROM OPERATION CFO IS 24% OF SALE.
WHERE IS THE FUND IN THE FUNDS FLOWSTATEMENT ?.
Continues . . . 9
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CONCEPT OF FUNDS FLOW HAS LOST ITSSIGNIFICANCE.
ACCOUNTING STD BOARD HAS STRESSED ON CASHFLOW AS REPLACEMENT FOR FUNDS FLOW.
CASH FLOW STATEMENT IS THE MOST POWERFULTOOL IN FINANCIAL EVALUATION.
ACCOUNTING PROFIT IS MEANINGLESS EXCEPT FOR
TAX PURPOSE.
TAX AUTHORITIES ARE NOW LOOKING FOR CASHPROFIT WITH INTEREST.
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Cash Flow Statement (Significance) :
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Integral to investment and credit decisions.
Measures ability to generate cash or cash equivalentsand to match the needs to utilize those cash flows.
Ability to measure the amount and timing of cashflows.
Compare the present value of future cash flows ofdifferent enterprises.
Enhances the comparability of reporting of operatingperformances by eliminating the effects of using
different accounting treatments for the sametransactions.
Future cash flow projections becomes easier.
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Power of Cash Flow Statement.
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INFLOWS OUTFLOWS
CASH FROMOPERATION
CFO
OPERATING
FINANCING
INVESTMENT
OTHER
OPERATING
FINANCING
INVESTMENT
OTHER
NCF
---------------------------------
OO
FO
IO
CFO > FO GROWTH FIRM
CFO = FO - STABLE
CFO < FO - DECLINING
CFO = 0 - SICK
CFO = -ve - ABSOLUTELY SICK
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Direct Method Cash Flow Statement.
Continues . . . 13
(Rs. 000)1996Cash flows from operating activities
Cash receipts from customers 30,150Cash paid to suppliers and employees (27,600)
Cash generated from operations 2,550
Income tax paid (860)
Cash flow before extraordinary item 1,690
Proceeds from earthquake disaster settlement 180
Net cash from operating activities 1,870
Cash flows from investing activities
Purchase of fixed assets (350)
Proceeds from sale of equipment 20Interest received 200
Dividend received 160
Net cash from investing activities 30
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Continues . . . 14
Net cash from investing activities 30
Cash flows from financing activities
Proceeds from issuance of share capital 250
Proceeds from long term borrowings 250Repayments of long term borrowings (180)
Interest paid (270)
Dividend paid 1,200
Net cash used in financing activities 1,150
Net increase in cash and cash equivalents 750
Cash and cash equivalents at beginning of period 160
Cash and cash equivalents at end of the period 910
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Cash flow parameters for performance analysis.
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The format of CF statement as per AS3 is more suitable forexternal users than for managers.
A manager can easily prepare the statement from cash book onweekly and monthly basis.
In order to plan outflows, cash flow can be divided into
Priority out cash flows (Int + Loan + Tax)
Discretionary cash flows
Objective of the manager should be to meet priority out cashflows from operating inflows.
Balance available should be used for discretionary outflows inconjunction with other inflows.
Following ratios can be used for analysis & control : Cash flow sufficiency ratio Cash flow efficiency ratio
Priority obligation ratio
Adequancy measure for priority outflows
CFO / Priority Outflows
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Sufficiency and Efficiency Ratios.
Continues . . . 16
Ratio(Sufficiency)
Formula Indication
Cash flow adequacy Cash from operations Ability to generate cash todividends paid + asset cover growth requirements. Apurchases + long term value >1 deemed satisfactorydebt paid cover
Long term debt payment Longterm debt payments Adequacy measure forCash from operations contractual payments
Dividend payout Dividends Payout ratio measure forCash from operations discretionary distributions
ReInvestment Asset purchases Outlay ratio measure forCash from operations discretionary investments
Debt Converage Total Debt Coverage used as payback howCash from operations many years, at current flows, will
it take to retire debt
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Sufficiency and Efficiency Ratios (Continued).
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Ratio(Efficiency)
Formula Indication
Cash flow to sales Cash from operations Ratio of sales dollar realisedsales as cash from operations
Operations Index Cash from operations Measures cash generating
Income from continuing productivity of continuingoperations operations
Cash flow return Cash from operations Measure return on assetsOn assets Total Assets (on cash generation basis)
Priority obligation ratio CFOPriority outflows
Depreciation-amortisation impact Depreciation + amortisation Ratio of non-cash items toCash from operations cashfrom operations
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Cash Flow Planning & Control:
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Forecasting of cash flows.
Monitoring and accelerating inflows. Controlling outflows.
Managing the balance.
Review and follow up action.
Forecasting of Cash Flows:
Long period vs short period forecasts. Forecasting methods and skills.
Details of forecasting variables.
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Cash Budget: The Primary CashManagement Tool
Purpose: Uses forecasts of cashinflows, outflows, and ending cashbalances to predict loan needs andfunds available for temporaryinvestment.
Timing: Daily, weekly, or monthly,depending upon budgets purpose.Monthly for annual planning, daily for
actual cash management. 19
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DATA REQUIRED FOR CASHBUDGET
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1. Sales forecast.
2. Information on collections delay.
3. Forecast of purchases and paymentterms.
4. Forecast of cash expenses: wages,
taxes, utilities, and so on.5. Initial cash on hand.
6. Target cash balance.
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SKIs Cash Budget forJanuary and February
Net Cash InflowsJanuary February
Collections $67,651.95 $62,755.40Purchases 44,603.75 36,472.65
Wages 6,690.56 5,470.90
Rent 2,500.00 2,500.00Total payments $53,794.31 $44,443.55
Net CF $13,857.64 $18,311.85
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Cash Budget (Continued)
January February
Cash at start ifno borrowing $ 3,000.00 $16,857.64
Net CF 13,857.64 18,311.85
Cumulative cash $16,857.64 $35,169.49Less: target cash 1,500.00 1,500.00
Surplus $15,357.64 $33,669.49
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Should depreciation be explicitlyincluded in the cash budget?
No. Depreciation is anoncash charge. Only
cash payments andreceipts appear on cash
budget.However, depreciationdoes affect taxes, which do
appear in the cash budget. 23
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What are some other potential cashinflows besides collections?
Proceeds from fixed asset
sales.Proceeds from stock and
bond sales. Interest earned.Court settlements.
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How can interest earned or paid onshort-term securities or loans be
incorporated in the cash budget?
Interest earned: Add line in the
collections section. Interest paid: Add line in the
payments section.
Note: Interest on any other debtwould need to be incorporated aswell.
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How could bad debts be worked into the
cash budget? Collections would be reduced by the
amount of bad debt losses.
For example, if the firm had 3% baddebt losses, collections would totalonly 97% of sales.
Lower collections would lead to lower
surpluses and higher borrowingrequirements.
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SKIs forecasted cash budget
indicates that the companys cashholdings will exceed the targetedcash balance every month, except forOctober and November.
Cash budget indicates the companyprobably is holding too much cash.
SKI could improve its EVA by eitherinvesting its excess cash in moreproductive assets or by paying it out tothe firms shareholders.
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What reasons might SKI have for
maintaining a relativelyhigh amount of cash?
If sales turn out to be considerably less than
expected, SKI could face a cash shortfall.A company may choose to hold large
amounts of cash if it does not have muchfaith in its sales forecast, or if it is very
conservative. The cash may be there, in part, to fund a
planned fixed asset acquisition.
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Speeding Up CashReceipts
Expedite preparing and mailing the invoiceAccelerate the mailing of payments from
customers
Reduce the time during which paymentsreceived by the firm remain uncollected
Collections
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Collection Float
Collection Float: total time between the mailingof the check by the customer and the availability
of cash to the receiving firm.
ProcessingFloat
AvailabilityFloat
MailFloat
Deposit Float
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Mail Float
Mail Float: time the check is in the mail.
Customermails check
Firmreceives check
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Processing Float
Processing Float: time it takes a companyto process the check internally.
Firmdeposits check
Firmreceives check
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Availability Float
Availability Float: time consumed in clearingthe check through the banking system.
Firmdeposits check
Firms bankaccount credited
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Deposit Float
Deposit Float: time during which the checkreceived by the firm remains uncollected funds.
Processing Float Availability Float
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Managing Float
Payers attempt to createdelays in the check clearing
process.Recipients attempt to
remove delays in the checkclearing process.
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Float
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Float.
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Float is associated with both collection & disbursement offunds.
Float is the time delay between mail of a cheque bythe customer and its realisation.
Can be of the types : Collection float (-ve float)
Disbursement float (+ve float)
Float is also the difference between book balance andbank balance.
Book balance > bank balance -ve float.
Book balance < bank balance
+ve float. Collection float + disbursement float is called Netfloat.
Objective of the manager should be to
generate +ve net float.
FLOAT
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FLOAT
A/c Credits Sales Billing
Customer mails cheque
Company receives cheque
Company deposits cheque
Comp processes
Billing float
MailFloat
Clearingfloat
ProcessingFloat
For accelerating inflows, collection float has to be reduced by followingMethods :
Lock box system Concentration banking Post dated cheques Electronic fund transfer
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Lockbox Systems
Traditional LockboxA post office box maintained by a firmsbank that is used as a receiving point for
customer remittances.
Electronic Lockbox
A collection service provided by a firmsbank that receives electronic payments andaccompanying remittance data and
communicates this information to the
company in a specified format.
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Lockbox Process*
Customers are instructed to mailtheirremittances to the lockbox location.
Bank picks up remittances several times dailyfrom the lockbox.
Bank deposits remittances in the customersaccount and provides a deposit slip with a list of
payments. Company receives the list and any additional
mailed items.
* Based on the traditional lockbox system
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Lockbox System
Disadvantage
Cost of creating and maintaining alockbox system. Generally, not
advantageous for small remittances.
Advantage
Receive remittances sooner which
reduces processing float.
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Concentration Banking
Compensating Balance
Demand deposits maintained by a firm tocompensate a bank for services provided,
credit lines, or loans.
Cash Concentration
The movement of cash from lockbox or
field banks into the firms central cashpool in a concentration bank.
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Concentration Banking
Improves control over inflows andoutflows of corporate cash.
Reduces idle cash balances to a
minimum. Allows for more effective investments by
pooling excess cash balances.
Moving cash balances toa central location:
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Playing the Float
You write a check today, which is subtracted from
yourcalculation of the account balance. The checkhas not cleared, which creates float. You can
potentially earn interest on money that you havespent.
Net Float -- The dollar difference betweenthe balance shown in a firms (or
individuals) checkbook balance and thebalance on the banks books.
EXTENSIONS OF FLOAT
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EXTENSIONS OF FLOATMANAGEMENT
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Understand the impact of payment andreceipt mechanism or cash flow time line.
Float refers to delay in value transferfrom the time a cheque is written until it is
finally charged to the account
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Exmpl :A cheque receipt per day Rs. 60 lakhs.Practice is to deposit cheques twice a week, Wednesdayand Friday
Received Reported Float
Mon Wed 2 X 60 = 120
Tue Wed 1x 60= 60
Wed Wed ----Thur Fri 1x60= 60Fri Fri ----
Sat Wed 3x60= 180
420 lakh
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Continuing float 420 lacs float days per week
Opportunity cost = 18% p.a
/20712.20712.0
365
0.18x420per weekfloattodueLoss
Rslakhs
Loss per annum = 20, 712 x 52 = Rs. 10,75
LOCK BOX SERVICES
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LOCK BOX SERVICES : Lock box system involves both a fixed and a variable cost
Fixed cost : Account maintenance fee,Transfer fee of thebalance
Variable cost : lock box processing charge
Total Cost = N [ F x D x i] + VC] + FC
N = no of remittances processed
F = Avg. face value of remittances
D = No of days it takes to clear the cheque
I = Daily Opportunity cost of fund
VC = variable cost for each remittance
FC = Fixed cost charged by the processor47
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Variable Processor A Processor BN 1000 1000F 1500 1500D 6 5 - loweri 0.10/365 0.10/365
VC
FC
0.45
225
0.50
275Higher
Ex:
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49
3140225)45365
0.106XX15001000(TC(A)
2830275)45365
.105XX15001000(TC(B)
Even if charges are higher lower processing time
generates savings.
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Assume there are 100 cheques of facevalue of Rs 15 per cheque.
Total amount is same.
TC(A) = 47,685
TC(B)= 52,325
With increased no of cheques and lowerface value Bank A provides lower total cost.
Float savings is less significant when thevalue of the cheque is small.
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Controlling Disbursements
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Controlling Disbursements.
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Making payment only when it is due and
availing cash discount. Stretching payables beyond the due date
when there is no discount without
impairing the credit standing. Paying through a centralized system.
Increasing the disbursement float
without affecting image.
S l i D
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S-l-o-w-i-n-g D-o-w-nCash Payouts
Playing the Float
Control of Disbursements
Zero Balance Account (ZBA)
Remote and Controlled Disbursing
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Control of Disbursements
Solution:Centralize payables into a single (smaller
number of) account(s). This provides better
control of the disbursement process.
Firms should be able to:
1. shift funds quickly to banks from which
disbursements are made.2. generate daily detailed information onbalances, receipts, and disbursements.
M th d f M i
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Methods of ManagingDisbursements
Eliminates the need to accuratelyestimate each disbursement account.
Only need to forecast overallcash needs.
Zero Balance Account (ZBA):A corporate checking account in which a zerobalance is maintained. The account requires amaster (parent) account from which funds aredrawn to cover negative balances or to which
excess balances are sent.
R t d C t ll d
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Remote and ControlledDisbursing
Example: A Vermont business pays a Maine supplierwith a check drawn on a bank in Montana.
This maystress supplier relations, and raises ethicalissues.
Remote Disbursement -- A system in which thefirm directs checks to be drawn on a bank that isgeographically remote from its customer so as to
maximize check-clearing time.This maximizes disbursement float.
FORMS OF INVESTMENT
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FORMS OF INVESTMENT.
Continues . . . 56
Invest in current account.
Increase reserve drawing power under cash creditarrangement.
Invest in marketable securities like treasury bills,commercial papers etc.
Invest in inter-corporate reports. Invest in M M Mutual fund.
Criteria of Investment :
Safety Liquidity
Yield
Maturity
Primary considerations
Secondary considerations
Investment in
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Investment inMarketable Securities
Marketable Securities are shown on thebalance sheet as:
1. Cash equivalents if maturities are lessthan three (3) months at the time ofacquisition.
2. Short-term investments if remainingmaturities are less than one (1) year.
The Marketable
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The MarketableSecurities Portfolio
Ready CashSegment (R$)
Optimal balance ofmarketable securitiesheld to take care of
probable deficienciesin the firms cash
account.
R$F$
C$
The Marketable
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Controllable CashSegment (C$)
Marketable securitiesheld for meeting
controllable (knowable)
outflows, such as taxesand dividends.
The MarketableSecurities Portfolio
R$F$
C$
The Marketable
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Free Cash Segment(F$)
Free marketable
securities (that is,available for as yet
unassigned purposes).
The MarketableSecurities Portfolio
R$F$
C$
Variables in Marketable
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Variables in MarketableSecurities Selection
Marketability (or Liquidity)The ability to sell a significant volume ofsecurities in a short period of time in the
secondary market without significant priceconcession.
SafetyRefers to the likelihood of getting back the
same number of dollars you originallyinvested (principal).
Variables in Marketable
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Variables in MarketableSecurities Selection
MaturityRefers to the remaining life of the security.
Interest Rate (or Yield) Risk
The variability in the market price of
a security caused by changes ininterest rates.
Common Money Market
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Common Money MarketInstruments
Treasury Bills (T-bills): Short-term, non-interest bearing obligations of the U.S.
Treasury issued at a discount andredeemed at maturity for full face value.Minimum $1,000 amount and $1,000increments thereafter.
Money Market InstrumentsAll government securities and short-term
corporate obligations. (Broadly defined)
T Bills and Bond Equivalent
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T-Bills and Bond EquivalentYield (BEY) Method:
BEY = [ (1000990) / (990) ] *[ 365 / 91 ]
BEY = 4.05%
BEY = [ (FAPP) / (PP) ] *[ 365 / DM ] FA: face amount of security
PP: purchase price of security
DM: days to maturity of security
A $1,000, 13-week T-bill is purchased for $990 what is its BEY?
T Bills and Equivalent
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T-Bills and EquivalentAnnual Yield (EAY) Method:
EAY = (1 + [.0405/(365 / 91)])365/91
- 1EAY = 4.11%
EAY = (1 + [ BEY / (365 / DM) ] )365/DM - 1 BEY: bond equivalent yield from the previous slide
DM: days to maturity of security
Calculate the EAY of the $1,000, 13-week T-bill purchasedfor $990 described on the previous slide?
Common Money Market
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Common Money MarketInstruments
Treasury Bonds: Long-term (more than
10 years original maturity) obligations ofthe U.S. Treasury.
Treasury Notes: Medium-term(2-10 years original maturity)
obligations of the U.S. Treasury.
Common Money Market
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Common Money MarketInstruments
Bankers Acceptances (BAs): Short-termpromissory trade notes for which a bank
(by having accepted them) promises topay the holder the face amount atmaturity.
Repurchase Agreements (RPs; repos):Agreements to buy securities (usuallyTreasury bills) and resell them at ahigher price at a later date.
Common Money Market
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Common Money MarketInstruments
Federal Agency Securities: Debt securitiesissued by federal agencies and government-
sponsored enterprises (GSEs). Examples:FFCB, FNMA, and FHLMC.
Commercial Paper:Short-term, unsecuredpromissory notes, generally issued by largecorporations (unsecured IOUs). The
largest dollar-volume instrument.
Selecting Securities for
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Selecting Securities forthe Portfolio Segments
Ready CashSegment (R$)
Safety and ability toconvert to cash is most
important.
Select U.S. Treasuriesfor this segment.
R$F$
C$
Selecting Securities for
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Controllable CashSegment (C$)
Marketability lessimportant. Possiblymatch time needs.
May select CDs, repos,BAs, euros for this
segment.
R$F$
C$
Selecting Securities forthe Portfolio Segments
Selecting Securities for
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Free Cash Segment(F$)
Base choice on yieldsubject
to risk-return trade-offs.
Any money market
instrumentmay beselected for this se ment.
R$F$
C$
Selecting Securities forthe Portfolio Segments
STEPS IN CASH CRISIS:
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STEPS IN CASH CRISIS:
Utilize unused credit limit
Sell marketable securities
Negotiate spacing of repayment schedule of term
liabilities
Negotiate for enhancement of short term credit
facilities with bank
Defer payment of suppliers bill
Advance slacks in cash out flows
Sell assets
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Ways to Minimize Cash Holdings
Use lockboxes.
Insist on wire transfers from
customers.
Synchronize inflows and outflows.
Use a remote disbursement account.
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REVIEW AND FOLLOW UP ACTIONS
Identify slacks in the system
Take remedial measures
Introduce improvements in thesystem.