Chapter 9
Cash Collection Systems
The Cash Flow Timeline
Order
Placed
Order
Received
< Inventory >
Sale
Payment Sent Cash
Received
Accounts
Collection
< Receivable > < Float >
Time ==>
Accounts
< Payable >
Invoice Received
Disbursement
<
Float
>
Payment Sent
Cash Disbursed
Learning Objectives

To understand the various options firms have to collect
customer payments.

To differentiate between the various collection system
and choose that system best suited for the company.

To collect the basic data necessary for a lockbox study.

To understand how a lockbox model works.
The Cash Flow Timeline for
Collection Float
Check
Mailed
Check
Received
Check
Deposited
Good Funds
Received
Time =>
Mail
Float
Processing
Float
Collection Float
Availability
Float
Collection Float

Collection float is the time interval between mailing of the
check and the date at which cash is made available at the
depositor’s account.

Mail float is the time that elapses from the point
when check is written until it is received by the
payee. Mail ranges from 1 day for local checks to 10
days for international checks

Processing Float is the period of time extending from
receipt of check until it is deposited in the payee’s
account. Small companies, governments and non
profits have normally higher processing float. It
ranges from few hours to one or more days.

The other name for “clearing delay” is known as
Availability Float. It can range from immediately to as
much as five days if weekends are involved.
Dollar Day Float & Annual
Cost of Float

Dollar Day Float is a popular concept used to calculate
the cost of float; it incorporates both the length of the
float and the dollar amount involved. It is calculated by
multiplying the individual remittances with the
corresponding collection float

Average Daily Dollar Day Float is calculated by dividing
the aggregate dollar day float by the number of days in
a month

Annual cost of float is the total dollar value the firm is
losing because of the collection float.
Cost of Float
Remittances
$ 50,000
1,200,000
500,000
1,000
------------$1,751,000
x
Collection Float
2
5
7
10
=
Dollar-Day Float
$ 100,000
6,000,000
3,500,000
10,000
------------$9,610,000
Average Dollar-Day Float = Dollar-Day Float/Days in month
=$9,610,000/30=$ 320,333.33
Average Collection Float = Dollar-Day Float/ Remittances
=$9,610,000/$1,751,000=5.49 days
Annual Cost of Float = Average Dollar-Day Float x Rate
=$320,333.33*.08=$25,626.67 [Assume, Rate= 8%]
Types of Collection Systems

Company processing centers- Management may decide
to process and deposit its own checks referred to as
company processing center. The competing types of
company processing centers include decentralized and
centralized processing system.

Lockbox systems
Company Processing Centers

Deciding which to use depends primarily on the volume
of the checks processed and the dollar size of the
checks.

Decentralized collection systems


With a decentralized collection system various field
officers or collection end points receive payments directly
from the customers.

Mail delay and Availability delay is minimal whereas
processing delay tends to be longer
Centralized collection systems

Corporate headquarters receives all customer remittance

Quick processing system thus less processing float. More
control over the funds.

Mail float and Availability float is normally higher.
Collection system Cost Factors
Company Processing Centers
Common data
N
1,000
F
$1,500
D
Decentralized
Centralized
7
6
VC
$0.25
$0.20
FC
$100
$600
i
0.10/365
Company Processing Centers

Total cost (Decentralized)
= $1,000 x [($1,500 x 7 x 0.10/365) + $0.25] + $100
= $3,226.71

Total cost (Centralized)
= $1,000 x [($1,500 x 6 x 0.10/365) + $0.20] + $600
= $3,265.75
Lockbox Collection Systems

A lockbox collection system is a blend of the two
company processing system with exception of that a bank
or a third party handles the processing.


Retail


Large volume of standardized invoice materials where checks have
low average face value
Wholesale


A lock box system consist of dispersed collection sites, similar to
the decentralized company processing centers and it resembles a
centralized collection system in that deposited funds are
transferred on a frequent basis from the lockbox collection sites to
the corporate headquarters.
Smaller volume with non standardized remittance information and
larger dollar amounts
Cost Factors,
TC = N x [(F x D x i/365) + VC] + FC
Lockbox cost analysis
Common data
Citibank
Chase
6
5
VC
$0.45
$0.50
FC
$225
$275
N
1,000
F
$1,500
D
i
0.10/365
Lockbox cost analysis

Total cost (Citibank)
= 1,000 x [($1,500 x 6 x 0.10/365) + $0.45] + $225
= $3,140.75

Total cost (Chase)
= 1,000 x [($1,500 x 5 x 0.10/365) + $0.50] + $275
= $2,829.79
Lockbox cost analysis
Common data
N
100,000
F
$15
D
i
Citibank
6
Chase
5
0.10/365
VC
$0.45
$0.50
FC
$225
$275
Lockbox cost analysis

Total cost (Citibank)
= $47,690.75

Total cost (Chase)
= $52,329.79
Lockbox Location Study

Customer groups



Best approach when customer group is relatively smaller
Remittance sample

The sample should reflect the size of the company

Should incorporate the largest dollar values
Mail availability schedule
The Lockbox Optimization
Model

The model determines the number of lockboxes that
will minimize total cost. In addition the model provides
the optimal lockbox locations and allocates the among
the selected lockbox sites.

Complete enumeration is a popular technique used to
optimize the number and use of lockbox sites, which
will ultimately maximize shareholder wealth.