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FIN - Cash Concentration Systems Case




Question;Cash Concentration SystemsFor firms having dispersed collection points, it is necessary to transfer funds from multiple banksaccounts to a single (or just a few) account(s). Conceptually, a cash concentration systemresembles a peer amid in design, moving funds from the broad base within the system (collectionpoints) to the apex (a single account)CustomersCustomersThe operation of the cash concentration system can broke down into three elements:1. The benefits and costs of a cash concentration system2. Methods of transferring funds3. Practical applicationsFirms realize several benefits of having funds located in a single (or just a few) accounts,including greater control, better cash management and investing opportunities, and potentially,the possible existence of positive dual balances when funds are moved between accounts.At the same time, operating a cash concentration system entails several costs, which include:? The administrative costs of managing the system? The cost per item when balances are moved upward within the system? The lost interest realized when funds accumulate in non-interest earning accounts (anopportunity costThe logistics of moving collected balances from the gathering point to the firm?s central bankcan be accomplished by using a mail depository transfer check (largely outdated today), anelectronic transfer via an automated clearing house (ACH), or a wire transfer. Of these three, wire transfers provide near immediate availability but are quite costly compared to ACH,therefore the cost effectiveness of a wire tends to be justified only if the dollar value beingtransferred is considerable. A firm?s cash flow timeline which highlights the basic points withinthe cash concentration system is a good starting point for some practical insights.Cash Inflow TimelineIn the timeline below, points T2, T5, and T6 are noteworthy since the firm possesses real value ateach of these moments. Also of note in this timeline is the existence of positive dual balancesshould be available balance of time T5 occur in advance of the reduced available balance at timeT6.The financial manager can generate increase shareholder value by skillfully controlling the cashconcentration system in several ways:1. Decide upon the optimal transferred to the use. The equation below can be used by thefirm to select the most cost efficient transfer method:Incremental Benefit = DS * [k ? ecr(1 ? rr)] * TBALWhere:? DS = The number of days saved the faster transfer method? k = The firm's investment opportunity rate? ecr = The bank's earnings credit rate? rr = The required reserve rate? TBAL = The balance to be transferredThe incremental benefits equation can be used by the firm to select the most cost efficienttransfer method.The dollar value of TBAL represents the minimum dollar amount of the balance beingtransferred in order to justify the specific tool. That is, while a wire transfer is costly. Bycomparison with ACH transfer, the fund availability at the receiving account is immediate andcan therefore be invested at the firm's opportunity cost rate. As a result, the firm can earn morethan the return earned at the firm?s field bank. Should this not be the case (e.g., if the firm istransferring cure excess balances), the opportunity cost of idle funds at the gathering bank isgreater (since ecr = 0), and the balance being transferred via a wire becomes significantly lower.2. Verify the trade-off between reducing excess balances versus the cost of frequenttransfers. The Total Cost equation is a good starting point to understand the relationshipbetween the goal of minimizing idle balances within the system and the cost of dailytransfers, which would be required to reduce excess balances to zero each day.The term FEE in the Total Cost equation represents the item cost, time AB is transferred betweenaccounts. This item is removed from the service charges (SC) so as to avoid double-counting itas part of SC. The term in parentheses in the equation, therefore, represents the opportunity costof idle balances the field bank whenever ACB > [(SC ? RCB)].3. Calculating the Minimum Balance to Transfer: The financial manager must weigh thecost associated with the transfer method against the amount of the transfer to ascertainthat the costs factor is reasonable. In its simplest terms, as the cost of the transferinstrument increases, the amount to be transferred must be sufficient enough to justify thehigher cost. Referring back to page 2, once you have calculated the Incremental Cost youare now able to calculate the Transfer Balance (TBAL) using the formula below:4. Finally, the cash inflow timeline reveals another value increasing strategy. Since the cashvalues held points T3, T5, and T6 of the timeline above represent real economic value tothe firm, the transfer process may be done in anticipation of the funds reflected at thosetimes. For example, since the firm will in all likelihood earn greater interest income whenit has AB edits concentration account as opposed to AB at the field bank, the transferpoint indicated at T3 can be moved earlier in the timeline in order to expedite the process.It should be noted. Care must be taken. Since only good funds (AB, and not ledgerbalances) can be transferred.


Paper#48643 | Written in 18-Jul-2015

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