Accelerating Collection of Funds by Reducing Collection Float PDF

Preview

Summary

Accelerating Collection of Funds by Reducing Collection Float...

Description

Accelerating Collection of Funds by Reducing Collection Float 1. Collecting center or agent. Float can be reduced by strategically locating collection center near the customer. The collection center can be a firm providing a collection service, or a bank where payments are made directly to the firm’s account. Having collecting center near the customer may even lead to a zero float, making the check collection as good as cash. A firm may also consider the possibility of having its own collecting agents or collecting centers, if it is economically possible to reduce the collection period in a certain area. The finance manager should be able to determine the additional cost associated with this separate set-up and the benefits attached to it to arrive at the possible solutions. 2. Lockbox system. It is a system where the company has a “P.O. box number” address. This P.O. box (Post Office box) is rented in a postal office where all collections made by the customer will be directed to. Lockboxes are normally managed by banks. A bank employee goes to the post office to empty the postal box and immediately deposits the check payment made by the customers. Several factors, like average size of the receipts from customers, quantity of receipts collected per day, and average number of mail received, have to be considered before selecting the location of the lockbox. A lockbox is not offered free by whoever is willing to render the service. Firms who like to avail of such a service have to consider the costs involved. A cost-benefit analysis has to be made before deciding whether or not to make use of the lockbox system. The variables in the analysis are: cost of the service, number of days in which the float is reduced, the amount of check to be converted immediately into cash, and expected rate of return on the cash freed. To be acceptable, the benefit should be greater than the cost of the lock box system. Below are some examples related to a lockbox system. 3. Concentration banking. This is another way of accelerating the collection of funds. A firm doing business over a wide geographical area normally maintains several accounts in different banks. The accounts are used for several reasons, including payroll of employees in the different parts of the country or region, payments to the suppliers, receipts of collections from customers, and other transactions that may be accounted as normal operations of the firm. The firm usually improves its total cash balances by collecting its receivables from different regions and electronically concentrating the transfer of funds to one bank or branch. The bank offers this type of service by signing a memorandum of agreement where all terms and conditions are stipulated. Normally, banks require a compensating balance or an average daily balance before such service is offered. One good example of concentration banking is the remittances made to Social Security System (SSS), whose main account is being maintained in the RCBC head office in Makati. This government agency has numerous accounts in the

different branches of RCBC all over the country. payment is deposited by individuals to the place where they are geographically located, say, in the RCBC Baguio branch. This receiving RCBC branch in Baguio in return will transfer the fund collection by debiting its account and crediting the main account of SSS in RCBC head office. Concentration banking has many forms. Some of them are: direct sends where checks are sent directly to the drawee bank; direct deposit to the company’s bank account, provided that the bank is already on-line; and an auto-debit arrangement wherein the payee’s account is credited while that of the payor is debited. Once collections have been accelerated, the amount of cash freed is immediately invested in marketable securities or used to pay off short-term obligations. With this investment, the firm is able to generate additional income in the form of interest on the investment. Likewise, if payment on obligation has been made, the firm will be able to minimize its cash outflow due to savings on the interest expense. The revenue obtained is determined by getting the average accounts receivable balance times the monthly interest rate. Extending Cash Disbursement Cash management has two sides: the cash inflow and the cash outflow. The previous discussions were about cash inflow or the acceleration of funds to support company operations and to gain additional income on the cash freed-up. The other half of cash management, the cash outflow, is concerned with how cash disbursements can be extended from the time the billing statement is received. Stretching payables is an obvious way of extending cash disbursements. However, this practice has drawbacks. At a certain point, after a series of contraction of the supply of money, the suppliers will no longer tolerate the firm’s practice, which will result in the cut-off of the credit line. Although may firms in the past and even at present have been doing this, the risk of losing their creditors is always a burden on their shoulders. Nevertheless, it is also not advisable to pay the obligation before the stipulated date. Paying the obligation on the date as agreed and using the money until the maturity date is a good practice. There are suppliers who grant cash discounts to buyers who pay their obligations within the discount period. If the buyer likes to avail of such a discount, a cost-benefit analysis has to be conducted before making a decision....