e ar
at r
Shopping for Cash Management
Services
Chip Hines, David N. Hurtt, and Sheldon A. Langsam
Cash is king.
Lou Basile,
Controller, Actrade
Capital
C
ash manage-
ment is general-
ly viewed as
one of the major components, if
not the major component, of
treasury management. The other
components of treasury manage-
ment include debt management,
investment management, and
risk management. There is a
very competitive market in pro-
viding cash management servic-
es to companies due to the enor-
mous amount of revenues gener-
ated in providing these services.
The 1999 Ernst & Young
Cash Management Services
Survey of 61 large banks found
that in 1993 cash management
service revenues were approxi-
mately $7 billion while 1999
cash management service rev-
enues were projected to be over
$10 billion.
Cash management services
appear to be dominated by the
largest banks. A list of the largest
banks, referred to as Peer I banks,
2000 John Wiley & Sons, Inc.
Cash management has always been one of the
major components of treasury management. But
today, a lot of companies are hiring outsiders to do
their cash management. Should you do that? And
if so, how much?
2000 John Wiley & Sons, Inc.
is presented in Exhibit 1. In 1994
the largest banks received about
56 percent of the total revenues
generated by cash management
services. By 1998 the market con-
centration of these large banks
had grown to 81.5 percent of cash
management services revenues.
Cash management service is a
growth segment for these large
banks, having an average annual
growth rate of approximately 6.25
percent over the 1993 through
1998 period and a projected
growth rate of 8 percent for 1999.
The remainder of this article
is divided into three distinct areas.
The first section presents the fun-
damentals of cash management.
The second section addresses the
question as to whether cash man-
agement services should be out-
sourced, while the last section dis-
cusses the types and pricing of
cash management services.
ticl
u
e
fe
FUNDAMENTALS OF
CASH MANAGEMENT
There may be no
financial discipline that
is more important, more
misunderstood, and
more overlooked than
cash management.
Jill Andreky Fraser,
Finance Editor of Inc.
The cash management area
of a company is usually defined
in terms of the management of
short-term assets and liabilities.
Daily cash management tasks
entail such things as collection
of accounts receivable, payment
of accounts payable, and concen-
tration of cash balances in order
to maximize interest earnings.
Reasons for Holding Cash
Balances
There are three basic reasons
for an entity to hold cash. The
first reason is to be able to
process transactions, such as
payments for goods and services
purchased. The second reason to
15
16 The Journal of Corporate Accounting & Finance

rowing at excessive interest

Exhibit 1 rates when contingent obliga-
tions occur.
Holding cash for investment
List of Largest (Peer I) Banks purposes provides an entity
with sufficient financial flexi-
BankAmerica bility to take advantage of busi-
BankBoston ness opportunities as they
Bank of New York become available. Situations
may arise where there is insuffi-
Bank One
cient time to arrange for outside
Bankers Trust
financing to take advantage of
Chase Manhattan investment opportunities.
Citicorp Sometimes outside lenders
First Union require companies to maintain
Fleet Financial compensating cash balances as
Key Corp security for loans. Holding suf-
Mellon Bank ficient cash can provide a
National City means for maintaining borrow-
PNC ing capacity, and cash balances
Republic NY may affect access to equity mar-
State Street kets, bond ratings, and interest
rates on borrowings.
SunTrust
Companies should under-
US Bancorp
stand the distinction between
Wachovia holding sufficient cash and
Wells Fargo holding substantial cash bal-
ances. Cash management theory
Source: 1999 Ernst & Young Cash Management Services Survey of 61 banks
implies that holding substantial
cash balances is not efficient. In
general, once a company has
cash sufficient to be able to
hold cash is for precaution. The its cash gap as follows: inven- handle transactions efficiently
third reason for holding cash is tory days on hand + receiv- and to meet short-term contin-
for investment or speculation ables collection period - gencies, cash balances should
purposes. accounts payable period = cash be minimized. Theoretically,
Cash inflows can be unpre- gap. The longer this time dif- excess cash should either be
dictable and generally do not ference, the greater the interest invested in real assets or distrib-
match cash outflows, therefore cost a company must bear, uted to shareholders in the form
it is necessary to maintain cash either in interest expense if of dividends.
balances sufficient to meet borrowing is required or inter-
daily requirements. Germain est revenue foregone if the
Boer, a professor of manage- company has cash balances Cash Management Principles
ment at Vanderbilt University, sufficient to finance the inven-
refers to the imbalance tory and receivables. The first basic principle of
between cash inflows and cash There are circumstances cash management is to acceler-
outflows as the cash gap. beyond the control of a compa- ate cash receipts and delay cash
Boer indicates that the cash ny where unexpected costs may disbursements. Decreasing the
gap is the number of days arise. When these conditions do accounts receivable collection
between a companys payment occur it is beneficial for a com- period can accelerate cash
of cash for goods and services pany to have some excess cash receipts. It should be noted that
purchased and the receipt of readily available. Holding cash the nature of the business gen-
cash for goods or services for precautionary purposes may erally affects the timing of cash
sold. A company can compute enable a company to avoid bor- collections. For example, a

2000 John Wiley & Sons, Inc.

November/December 2000 17

retailer such as K-Mart collects rate the cash management of be outsourced. The main bene-
cash from customers before they these activities as long as there fits of outsourcing cash man-
walk out of the store, while a is proper accounting for the agement services are:
manufacturing firm generally respective cash balances.
must provide 30-day payment Freeing up resources to
terms. Nevertheless, careful invest in core business activ-
monitoring of customer receiv- Outsourcing of Cash ities;
able balances and regular contact Management Services Allowing senior finance and
with customers will minimize treasury management staff to
the average collection period. Outsourcing to me says: use and analyze information
For cash disbursements, Take the whole thing, but theres rather than merely generat-
although payment terms are gen- got to be significant monitoring. ing it;
erally based on industry tradi- Then you spend as much time Achieving economies of
tion, a company may be able to looking over their shoulder as scale by reducing overhead
delay cash payment by negotiat- doing it yourself, so you might and operating costs;
ing longer payment terms on as well do it yourself with their Accessing world-class
inventory purchases. input. expertise and experience that
The second basic principle Robert Mahoney, is available at financial insti-
of cash management is to cen- Treasurer and CFO, Molex tutions; and
tralize cash receipts. Cash Enabling the company to
receipts should all go into a Should you outsource cash focus on its core business
central location in order to management services? and run a lean operation.
enhance control over cash According to John Cump of
receipts. Better control over Phoenix-Hecht, the issue is not When evaluating potential
cash receipts allows the compa- should you outsource but the outsourcing opportunities, cash
ny to maximize the interest degree to which a company management services is often
earned on the investment considered one of the easiest
of short-term cash bal- components of treasury
ances. A company can management to outsource
consider decentralization Cash for operating, financing, and as almost all banks provide
of cash disbursements in investing activities should be pooled in some types of cash man-
order to provide additional order to maximize interest earnings. agement services.
time for checks to clear However, there are sev-
through the banking sys- eral concerns related to
tem. Additionally, cash dis- outsourcing of cash man-
bursements should be post- should outsource its cash man- agement services. First, out-
poned until payment is required. agement services. Jack Large of sourcing of cash management
The third basic principle of J&W Associates indicates that services will result in the down-
cash management relates to the the question for many finance sizing of in-house corporate
investment of cash while it is in and corporate treasury depart- treasury department staff. A
the companys possession. Very ments is not whether to out- decline in staff may result in the
simply, immediate investment of source but what and when. loss of competent employees and
cash is smart business, since Outsourcing is allowing an have a negative impact on com-
uninvested cash earns no inter- outside party to do things for pany morale. Second, the deci-
est. Every company should have your business. Each company sion to outsource will make it
a policy in place for investing must decide what activities an necessary to rely heavily on a
excess cash balances. expert third party can perform third party for service. And last,
The last basic principle of more efficiently than can be there is often a concern that con-
cash management relates to the performed internally. When fidential information provided to
pooling of cash. Cash for operat- evaluating which activities to an outside third party may not be
ing, financing, and investing outsource a company must dis- secure. There is a concern that
activities should be pooled in tinguish between its core and funds may disappear, or be poor-
order to maximize interest earn- noncore business activities. ly managed and controlled by
ings. There is no reason to sepa- Only noncore activities should the third party.

2000 John Wiley & Sons, Inc.

18
Aengus Murphy, chairman
of FTIa financial consultancy
and outsourcing firm based in
Dublin, Irelandindicates that
outsourcing cash management
services is not ideal for every
company. A large multinational
corporation may be better off
developing the expertise in-
house; while a small company
may have too few transactions to tionships more than any other
make outsourcing worthwhile.
The ideal candidate for out-
sourcing of cash management
services appears to be midsize
companies with growing levels
of foreign currency exposure.
Stryker Corporation, which
develops, manufactures, and
markets surgical and medical
products, appears to fit the pro-
file of a company that can bene- the basic types of cash manage-
fit from outsourcing cash man-
agement services. Stryker is a $2 telephone interview with John
billion company with plant and
operating facilities world-
wide and its headquarters
in Kalamazoo, Michigan.
Due to operations in
about 20 different
European countries,
Stryker Corporation
decided to outsource its
cash and foreign
exchange management for
the companys European
operations. Stryker selected
Bank of America as the provider ment consulting company.
of these cash management serv-
ices. According to Chris
Homrich, treasurer of Stryker
Corporation, Partnering with
Bank of America really helped
us to leverage off the banks
expertise. They really helped us
to better understand the com-
plete range of costs embedded in cash management services, it
European cash management
pricing structures. Homrich
indicated that outsourcing had
resulted in annual savings of
several hundred thousand dol-
lars because of better use of
The Journal of Corporate Accounting & Finance
idle cash and reduction in for-
eign exchange costs.
CASH MANAGEMENT SERVICES
Cash management is the
product with the longest life cycle
for the customer, and the product
that gets you the intimate rela-
product. They are the best rela-
tionships you can have.
Maarten Mol, ABN AMRO
Basic Types of Cash
Management Services
To obtain information about
ment services, we conducted a
Cump of Phoenix-Hecht, the
The ideal candidate for outsourcing
of cash management services
appears to be midsize companies
with growing levels of foreign cur-
rency exposure.
leading nonbank cash manage-
According to Cump, there are
over 1,500 different types of
cash management services
offered to companies. These
types of services range from
basic to esoteric. When
Phoenix-Hecht conducts its
research on pricing trends in
focuses on the most prevalent
services. Most of the 51 servic-
es studied by Phoenix-Hecht
can be categorized into one of
the following types of cash
management services:
Checking (Demand Deposit);
Lockbox Services;
Disbursement Services;
Automated Clearing House
(ACH);
Sweep Accounts; and
Wire Transfers.
The first type of basic serv-
ice is essentially the maintenance
of a demand deposit account on
which a company can write
checks to pay for goods and serv-
ices. Check reconciliation servic-
es are offered with demand
deposit accounts and can range
from full to partial account recon-
ciliation maintenance. With full
reconciliation maintenance serv-
ice, the bank compares the list of
checks paid against the compa-
nys account to a list of the com-
panys outstanding checks and
reconciles the two lists. Partial
reconciliation maintenance is
basic reconciliation in which a
bank merely provides a com-
pany with a listing of checks
paid against its account.
Companies can also select
full account reconciliation
processing where a bank
sorts checks according to a
requested sequence and pro-
vides the company with a
listing.
The second type of service,
the lockbox, is a traditional
service provided by banks. The
lockbox is a bank-maintained
account into which a companys
customers directly send pay-
ments. The bank processes the
checks received and deposits
the payments directly into the
companys account. The lock-
box helps companies collect
cash quickly and improves
internal control by separating
the cash handling duties from
the cash record-keeping duties.
The third type of basic serv-
ice listed above is disbursement
2000 John Wiley & Sons, Inc.
November/December 2000
services. An example of a dis-
bursement service is a controlled
disbursement account. With this
type of service the bank totals the
checks that will clear and informs
the company. This information
enables a company to keep only
necessary funds in the account
and to invest excess cash.
The next basic cash manage-
ment service listed above is the
automated clearing house. The
ACH system allows funds to be
transferred electronically between
banks. ACH is considered rela-
tively inexpensive (5 to 10 cents
per transaction) and easy to use.
An ACH transaction is an elec-
tronic check used to pay for
goods and services. It can be
used only between financial insti-
tutions. By paying for goods and
services electronically, companies
can reduce the amount of admin-
istrative paperwork, reduce the
cost of account reconciliation,
and use employees for more
important tasks.
Sweep accounts are cus-
tomized checking accounts that
automatically sweep excess
cash into some type of investment
account. For example, when a
companys sweep account balance
exceeds a certain designated limit
(for instance, $5,000), the excess
cash can be swept into a money
market account. Sweep accounts
can be customized in any way (for
example, end of day sweep
accounts) and excess cash can be
swept into any type of investment
(for example, stocks, bonds, treas-
ury bills).
Chip Hines, Ph.D.,CPA, is an associate professor in the Department of Accountancy of the Haworth College
of Business, Western Michigan University. David N. Hurtt, Ph.D., CMA, CPA, is an assistant professor in the
Department of Accountancy of the Haworth College of Business, Western Michigan University. Sheldon A.
Langsam, Ph.D., CPA, is a professor in the Department of Accountancy of the Haworth College of Business,
Western Michigan University.
2000 John Wiley & Sons, Inc.
The last basic cash manage-
ment service listed above is
wire transfers. This type of cash
service is important, but it is
expensive and considered more
exotic than the other types of
basic services. A wire transfer
allows a company to receive
cash directly from the bank of a
customer or move cash to the
bank of a vendor without paper-
work. The primary difference
between a wire transfer and
ACH is that a wire transfer is
faster than ACH since ACH
transfers usually require at least
one day of anticipation and
ACH is a batch process.
Pricing of Cash Management
Services
Phoenix-Hecht
(www.phoenixhecht.com) pub-
lishes an annual survey on the
actual prices paid for the most
commonly identified cash man-
agement services. Data for the
survey is gathered from more
than 1,000 companies. Most com-
panies in the survey had revenues
exceeding $100 million. Phoenix-
Hecht indicates that survey find-
ings generally represent the
prices that banks now give to cus-
tomers with significant negotiat-
ing leverage.
In a January 2000 article in
the Controllers Report where
the results of the survey were
reported, it was highlighted that
in terms of pricing for cash man-
agement services:
19
Pricing of cash management
services remains a secondary
issue that affects, but does not
dictate, banking relationships.
Even though mergers in the
banking industry have elimi-
nated many competitors,
banks are not increasing
prices directly and aggres-
sively for their cash manage-
ment services.
The prior years rate of
inflation was the most reli-
able predictor for price
increases for cash manage-
ment services.
Increases in price for cash
management services come in
subtle forms through repack-
aging or bundling cash
management services as new
and improved.
Pricing of cash management
services to individual compa-
nies varies widely from bank
to bank and within one bank
to different customers.
The wide price variation for
many cash management serv-
ices probably reflects the dif-
ferent service elements banks
attach to the same service.
The bottom line in terms of
pricing of cash management serv-
ices is that companies need to
check bank charges periodically
and evaluate the cost of cash
management services. Cash man-
agement services can be viewed
as a commodity and as such there
may exist opportunities to negoti-
ate price discounts for cash man-
agement services.
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