Innovations in short-term financial management

Business Horizons, Nov-Dec, 1989 by William L. Sartoris, Ned C. Hill

The electronic revolution has radically altered the short-term management of financial resources; it has also radically altered the jobs of those who have performed those functions.

People used to call short-term financial management "working capital management." This term focused attention on the accounting definition of working capital, current assets, and current liabilities. More recently, "short-term financial management" has been used to focus attention on all decisions of an organization that affect cash flows in the short term-usually less than a year.

The cash flows for most organizations can be thought of in three ways: permanent" cash inflows, primarily collections resulting from sales; internal cash flows; and "permanent" cash outflows, primarily payments to vendors and employees. The cash inflows and outflows are usually consequences of operating decisions. Internal cash flows consist either of cash being moved within the firm or "temporary" cash flows, such as an investment in a marketable security or a takedown under a line of credit. Some internal cash flows may involve external agents, but the intent is that the cash flow will be reversed at some future time. Internal cash flows usually are between a liquidity reserve, in the form of available cash or marketable securities, and backup liquidity, in the form of credit arrangements or access to additional credit.

Although the treasury manager-perhaps called cash manager, assistant treasurer, or treasurer-has direct responsibility for managing the short-term cash flows, the operating activities that generate the cash flows are frequently controlled by others in the organization. The players and the impact of their decisions on the timing and amount of cash flows are illustrated in Figure 1. For example, in the selling activities of a firm, credit and marketing managers have a major influence on the sequence of orders and the timing and form of payment. For buying activities, purchasing and payables managers determine when the cash outflow is initiated. The treasury manager's role historically has been limited to designing the collection or disbursement system, to manage the flow of cash after the payment is initiated, and arranging for financing.

One problem of having many people involved in the decision process is a lack of coordination. Separation by physical location and by position on the organization chart frequently results in suboptimal, segmented decisions. Changes in competition, technology, and institutional arrangements have both increased the need for streamlined organizations and altered the way business is conducted. In many organizations the treasury manager is in a good position to perform an integrative role for short-term decisions. Because he has responsibility for both the collection and payment systems, the treasury manager knows both the selling and the buying side of the firm. Additionally, the treasury manager needs to identify the impacts and coordinate the activities of other players to prepare accurate short-term budgets and cash forecasts and to provide financing.

Over the last few years several financial and technological changes have begun to alter the role of the treasury manager. Below we discuss three of these developments: changes in economic conditions and the payments system; new investment and risk-management vehicles; and the development of electronic data interchange (EDI).

CHANGING ECONOMIC CONDITIONS AND PAYMENT SYSTEMS IN THE EARLY 1980S

Much of the focus on short-term finance during the late 1970s and early 1980s was on cash management issues. Interest rates were at historically high levels. The payment system was hampered by inefficient physical movement of paper through the mail and the check-clearing systems. At an interest rate of 20 percent, speeding collection (or slowing payment) on $1 million by one day was worth approximately $550. Cash management efforts were understandably concentrated on optimizing the value of float.

Corporations learned to use the system to their advantage. One tactic was to expand the use of lockboxes. A lockbox is essentially a post office box, frequently with a unique zip code, to which a particular company's incoming checks are directed. The checks are collected by a bank as often as 20 times a day so they can be processed and quickly entered into the clearing system. The lockboxes are geographically located to minimize a check's mail time and availability time (the time until a deposited check's funds become available). High interest rates made multiple lockbox locations economical.

Remote disbursing to extend the time until a written check is presented for payment was another aggressive technique used. Checks drawn on banks in small towns in Washington, Montana, North Carolina, or even Guam were not uncommon. One aggressive midwestern grocery chain wrote checks one day prior to the due date and express mailed them to New Orleans to be mailed individually from a branch post office. The checks were drawn on a bank in a small town in South Carolina. While the extra mail time delay was a direct cost to the receiving firm, the extra clearing delay to the bank in South Carolina was borne by the banking system or the Federal Reserve.