PRINCIPLES THAT ENDURE
Windy City Summit
CTP Review
Chapter 8
Service
Expertise
Integrity
Presented by: Dan Carey
© 2011
2012 Northern Trust Corporation
northerntrust.com
Chapter 8
Cash Management and Forecasting
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Introduction
Treasury’s fundamental responsibility is to determine
and manage the daily cash position.
The primary objective of establishing the cash position
is to plan the day’s borrowing or investment
decisions based on whether the closing position is
projected to be a shortfall or surplus.
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Liquidity Management
Effective
liquidity management provides for a
company to meet its daily obligations without
incurring the opportunity costs that come from
holding excess cash or from not having enough
cash on hand to meet obligations.
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Cash Inflows and Outflows
Short-Term
Investments
Collections
(Cash Inflows)
Concentrated
Cash Position
Disbursements
(Cash Outflows)
Short-Term
Borrowing
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Liquidity Management
Reasons to maintain liquidity
Transaction Requirements – Inflows and outflows are
uneven, creating unexpected demands for cash
Precautionary Requirements – To address unexpected
obligations
Speculative Requirements – To address unexpected
investment opportunities
Regulatory Requirements – In some industries liquid
or a “safe” funds level must be maintained.
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Liquidity Management
Proper level of liquidity
It is important that adequate liquidity be
maintained.
Opportunity costs are associated with paying
more interest on a loan than necessary or
losing interest earnings.
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Liquidity Management
Stress Test of liquidity policy or contingency
funding plan
Test assumes an adverse shock to a company’s funding
sources such as competitor’s action, litigation issue, product
recall, plant disaster or some other trauma.
The proposed sudden change in funds availability could
involve the loss of a funding source, decrease in credit
rating or violate loan covenants. All of these resulting
events can increase the cost to borrowing significantly.
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Using Short-Term Investments for Liquidity Management
Market for debt and equity instruments
Two major components
Money Markets – short-term debt securities
Capital Markets – longer-term debt and
equity securities
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Short-Term Investment Markets and Instruments
 Money
U.S.
Market Participants
Treasury
Federal
agencies
Government-sponsored
Securities
enterprises (GSE’s)
dealers
Banks
Thrifts
Individuals
via money markets and money market mutual
funds
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Short-Term Investment Markets and Instruments
Money Market Instruments
U.S.
Treasury Bills (T-Bills)
Federal
agency and government sponsored enterprise
(GSE) securities
Bank
issues
Corporate
commercial paper
Municipal
notes and commercial paper
Money
market mutual funds
Short-term
mutual funds
Repurchase
Hedge
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Agreements
Funds
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Investment Strategies
 Matching
- purchasing securities that mature when another
obligation is due
 Requires
careful forecasting of future cash flows
 Ride
the Yield Curve - buying highly liquid marketable
securities that mature on day other than intended sell date
curve is upward sloping or normal – purchase securities that
mature beyond time when funds are needed
 Yield
curve is inverted or downward sloping – purchase securities
that mature before funds are needed
 Yield
 Tax-Based
 Yield
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Strategies
advantage is directly related to investor’s marginal tax rate
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Role of Short-Term Investments
 Liquidity
- helps adjust for working capital imbalances
 Temporary
surplus funds generated by:
Ongoing
Operations
Seasonal
Performance
Asset
Sales
Securities
Issuance
 Surplus
funds held temporarily to address specific dollar
distributions at specific times in the future
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Investment Risk Considerations
Factors that Influence Short-Term Investments
Credit or Default Risk – risk that payments on a security
will not be made under the original terms
Liquidity Risk – risk that a security cannot be sold quickly
without a significant financial loss
Market or Price Risk – uncertainty over the price at which
a security can be sold prior to maturity
Longer maturities = More price risk
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The Yield Curve
•
Normal Yield Curve
Percentage Yield
•
•
Inverted Yield Curve
Depicts differences in yield of
securities that are identical except
for maturity.
Normal Yield Curve - The longer
the maturity, greater price risk and
higher the yield. Most common
Inverted Yield Curve - The longer
the maturity, the lower the yield
stemming from expectations that
future rates may decline. Demand
for locking in long-term in a
declining rate environment drives
the yield for those securities down.
Time to Maturity
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Using Short-Term Financing for Liquidity Management
 Three
Primary Sources of Short-Term Funds
Spontaneous
Sale
financing such as trade credit
or factoring of accounts receivables
Borrowing
 Short-Term
Ensure
arrangement with banks
Financing Objective
adequate availability of credit while:
Minimizing cost
Minimizing risk
Maximizing flexibility
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Short-Term Financing
 Strategic
 Level
 Mix
Objectives guide planning for:
of debt
of debt among short-, intermediate- and long-term sources
 Appropriate
 Factors
mix of debt and equity
Influencing Financing Costs
 Risk
 Liquidity
 Length
of maturity
 Fees
 Credit
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enhancement and backup credit costs
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Short-Term Funding Alternatives
 Trade credit
 Internal borrowing
 Asset sales
 Line of credit
 Commercial bank credit
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





Single payment notes
Reverse repurchase agreement
Revolving credit agreement
Commercial paper (CP) issue
Asset-based borrowing
Banker’s Acceptance (BA)
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Short-Term Funding Alternatives - Notes
 Reverse
Repurchase Agreement (Reverse repo)
Securities
Seller
sold to bank providing seller with cash
repurchases securities at later date
Seller
accesses liquidity of portfolio without disposing of
investments
 Line
of Credit – Cost Components
All-in
interest rate
Commitment
fees
Compensating
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balances
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Short-Term Funding Alternatives (Cont.)
 Commercial
Paper (CP)
Short-term,
unsecured promissory note issued in the
money markets with maturity of 270 days or less
CP
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is issued at a discount
Sold
through dealers or directly
May
be backed by standby letter of credit (LC)
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Cash Concentration and Pooling Systems
Global
Concentration of Funds
International companies need to concentrate cash to use
all available cash more efficiently.
The typical method of concentrating cash is known as
pooling.
Pooling has three forms:
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1.
Notional pooling
2.
Physical pooling
3.
Bank Overlay Structure
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Notional Pooling
This type of pooling requires a company’s
subsidiaries to use branches of the same bank.
All excess and deficit balances in the company’s subsidiary accounts are
summed each day to calculate the net interest earned or due. Funds are
not actually transferred. They are totaled for the purpose of calculating
interest.
Banks usually require credit facilities to support any deficit balances in
the pool.
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Physical Pooling
This type of pooling requires the use of a single
currency. Balances are transferred out of the subaccounts and into a main account on a daily basis.
Physical pooling can be used in cross-border structures but since there is
one main account for each currency this method is expensive and more
complex.
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Bank Overlay Structure
Bank overlay structure is an approach that combines both
sweeping and pooling. It is typically used when a
company’s primary bank has branches in several countries
but the branches do not provide a full range of domestic
banking services.
(See Exhibit 8.2 in the text)
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Cash Concentration and Pooling Systems
Cash
Concentration Systems (U.S.)
Two major objectives of a cash concentration system are:
To
efficiently move funds from local or regional deposit banks
to the primary concentration bank.
Minimize
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excess balances.
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Over The Counter/Field Deposit Systems
Receipts
collected at local offices or retail
locations.
Cash
Checks
Credit/Debit Cards
Remote
Virtual
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Deposit Capture
Vault
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Cash Concentration System Configuration
Configuring
a company’s cash concentration
system involves three main considerations:
1.
The size and geographic distribution of its collection
system.
2.
The transfer alternatives for concentrating funds.
3.
The branch footprint of its banking network.
Study Example of Break-even Wire Transfer Amount Calculation
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Break-even Wire Transfer Amount Calculation
Wire
vs. ACH Breakeven Computation
Total
ACH costs are $ 1.00
Total
wire costs are $ 10.00
Opportunity
Wire
cost is 3.5%
accelerates funds one day faster than ACH
Minimum transfer = Wire Cost – EDT Cost
Days Accelerated X Opportunity
Cost/365
= $ 10.00 - $ 1.00
1 Day X .035/365 = $ 93,857
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Cash Concentration and Pooling Systems
Concentration System Costs
The
number of banking relationships a company has will
impact the transfer and administrative costs of a
concentration system.
Components include:
Excess Balances
Bank Charges
Administrative Costs and Responsibilities
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Cash Forecasting
Steps
Estimate
future operating cash inflows and outflows
Generate
a pro forma cash position
Identify
how to cover any cash deficits or use any cash
surpluses
Process
Forecasting
Cash
flow components
Degree
of certainty
Selection
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horizon – short, medium, long
and validation of method
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Cash Forecasting
Forecasting Methods
Receipts
and disbursements forecast
 Core of short term cash forecasting
 Create separate schedule of cash receipts and
disbursements
 Complete forecast and compare to minimum cash
balance
Distribution
Forecast
 Estimate impact of single event/transaction type
 May use simple average or regression analysis
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Cash Forecasting
Pro Forma Financial Statements
Forecast
cash flows over longer horizon
Uses
historical relationship between sales and liquid
balance sheet accounts to forecast specific balance sheet
values
Other
balance sheet accounts not related to sales use other
factors to forecast accounts
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Projected Closing Position
Opening
available balance
Plus
paper and electronic collections and
concentration
Less
disbursements
Uses
prior day and same day information
Certain
transaction types must be estimated
Closing
position used to determine if cash
surplus of deficit
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Cash Management Risks and Controls
Internal Controls
Use checks and balances
Separation
Periodic
of duties
audits
External Fraud
Positive
ACH
Pay
Debit blocks
Bank Failure
Monitor credit worthiness of your bank
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Questions for Chapter 8
1.
2.
3.
4.
5.
6.
7.
8.
What is the significance of the lack of synchronization between cash
inflows and outflows?
What is liquidity and why is managing it an important treasury
responsibility?
What are the primary considerations in short-term investment management?
What is the primary objective of short-term investment financing?
Describe pooling and explain where and why it is used?
What factors are used to determine whether funds should be wired or
transferred using the ACH system?
Define when an account is considered to have excess balances?
For what types of disbursements is a distribution forecast most useful?
9. What is a receipts and disbursements forecast and how is it used?
10. What process is used to determine a projected cash closing position?
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