Page 96 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 6: Managing Collection and Disbursement of Working Capital

but some it cannot. Some of the lags affect the cash balance, while others affect other components Notes
of working capital such as accounts receivable and inventory. In addressing ourselves to Cash
management, we are concerned with time periods BCD and FGHI. Time period AB is beyond the
firm’s control and does not directly affect its financial statements, although it may affect
production schedules. Time period BE is determined by the firm’s production process and
inventory policy, and affects the total investment in inventory. Time period EF is determined by
the firm’s credit terms and the payment policies of its customers, and affects the total investment
in accounts receivable.
Our present task is to examine what can be done to improve the efficiency of a firm’s cash
management. We will focus on three areas: concentrating working balances, speeding collections,
and controlling disbursements.

6.1.1 Concentrating Banking

Many firms need only a single bank account. Larger firms that operate over wide geographical
areas usually need more than one, sometimes dozens. Where many accounts are needed,
concentration accounts can be used to minimise the total requirement for working balances.
Suppose a company has a number of branch offices, each with a local bank account. Branches
collect accounts receivable and make deposits in their local accounts. Each day, funds above a
certain predetermined minimum level are transferred to a central concentration account, usually
at the firm’s headquarters.

Notes The daily transfer of funds can be made either by a depository transfer check or by
Fax/TT; the latter is faster but more expensive.
The funds transferred to the concentration account are available for disbursements and for other
purposes. As we will see later, the more variable a firm’s cash flows, the higher the requirement
for working cash balances.

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Caution By pooling its funds for disbursement in a single account, the aggregate requirement
for working balances is lower than it would be if balances were maintained at each branch
office. Concentration in short, permits the firm to “store” its cash more efficiently.

6.1.2 Speeding Collections

Another means of conserving cash is to reduce the lag between the time the customer mails the
cheque and the time the funds become collected, that is, from points F to I in Figure 6.2. Of the
6 days lag in Figure 6.2, 2 days are due to mail time, 2 days are due to processing time within
XYZ Corporation, and 2 days are due to collection time required by the bank. We will have
more to say later about collection within the banking system. Let us now focus on the 4 days lag
from F to H.
Small firms that operate over scattered geographical areas can often do little to reduce mail
time. However, improvements can be made in processing time within the firm. Suppose XYZ
Corporation has credit sales of `5 crore per year. With approximately 250 working days per
year, XYZ’s collections average ` 2,00,000 per working day. If XYZ could reduce such credit sales
even by ` 20,000, (XYZ’s borrowing cost was 9 per cent) saving of about ` 1,800 per year would
be realised. This potential saving could be compared to the cost of faster processing to determine

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