Page 97 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes whether the change in processing should be made. We can conclude that internal processing
should be speeded up to the point at which the costs of further improvement exceed the savings.
A second step that may be advantageous is to establish a lock-box system, which often can
reduce mail and processing time still further. The firm first establishes a number of collection
points, taking account of customer locations and mail schedules. At each location, the firm rents
a post office box and instructs its customers to remit to the box. The firm’s local bank is authorised
to pick up mail directly from the box. The bank does so, perhaps several times a day and deposits
the cheques in the firm’s account. The bank’s computerized system prepares a record of names
and amounts and other data needed by the firm for internal accounting purpose, even as it enters
the cheques for collections/clearing on the respective schedules.
The lock-box system results in two benefits to the firm. First, the bank performs the clerical tasks
of handling the remittances prior to deposit, services which the bank may be able to perform at
lower cost. Second, and often more important, the process of collection through the banking
system begins immediately upon receipt of the remittance and does not have to wait until the
firm completes its processing for internal accounting purpose. In terms of the activities in
Figure 6.2, the activity represented by HI now takes place simultaneously with GH. The firm
processes remittances for internal accounting purpose using data supplied by the bank and can
schedule this processing at any time without delaying collection. Using lock-box systems, as
much as 4 days in mailing and processing time can be reduced.

Did u know? Banks charge for their services in connection with a lock-box plan either via
fees or compensating balance requirements. Whether the savings will outweigh the costs
for a particular company depends mainly on the geographical dispersion of customers,
the amount of the average remittance, the firm’s cost of financing.
We see that a major advantage of speeding collections is freeing of blocked cash and thereby
reduction in the firm’s total financing requirements. There are other advantages as well. By
transferring clerical functions to the bank, the firm may reduce its costs, improve internal
control, and reduce the possibility of fraud. By getting cheques to banks on the day when they
are written dropped or soon thereafter, the incidence of cheques getting dishonoured for
insufficient funds in the drawers’ accounts may be reduced.

Task On the basis of the above discussion, analyse and discuss why speeding collections
important.

6.1.3 Collection Time in the Banking System

We have made several references to the time required to collect a cheque through the banking
system (HI in Figure 6.2) but we have made no proposals to shorten it. Let us look at the process
of cutting down the collection time in the banking system.

Example: Suppose a customer in New Delhi, purchases electronics equipment from a
firm in Mumbai, and remits a cheque drawn on a New Delhi Bank. The seller deposits the cheque
in a bank in Mumbai, but the funds are not available for use until the cheque has been presented
physically to the New Delhi bank, a process that depends on mail service between the two cities
and may take several days. A very extensive clearing network has been established in India that
involves the commercial banks and the RBI. In the majority of cases, collection times have been

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