Float: Meaning and Types | Financial Management

In this article we will discuss about:- 1. Meaning and Sources of Float 2. Types of Float 3. Management of Float 4. Electronic Cash Management System 5. Virtual Banking.

Meaning and Sources of Float:

Float refers to ‘the amount of money tied up between the time a payment is initiated and cleared funds become available in the company’s bank account’. The efficiency of firm’s cash management can be enhanced by having knowledge and use of various procedures aiming at accelerating cash inflows and controlling cash outflows.

Float refers to the period that passes before a payment or receipt is made by a bank. It is the transit time of receipt or payment. The float should be managed efficiently to reduce the length of cash cycle.

The sources of float are discussed below:

i. Billing Float:

After the goods are dispatched to the customer, an invoice is raised by the seller for the goods consigned. It is a formal document asking the customer to pay the amount mentioned in the invoice document. The time elapse between the sale of goods and mailing of invoice is called as ‘billing float’.

ii. Bill Mailing Float:

It is the delay between the bill/invoice despatched by the company and receipt of it by the customer.

iii. Credit Period:

In business practice, the customers are allowed certain credit period, say 30 days after the receipt of the bill/invoice by the customer.

iv. Cheque Mailing Float:

It is the delay between the time the cheque is sent by the customer through mail and the time that the cheque arrives at the seller’s office.

v. Cheque Processing Float:

When the firm receives amounts in the form of cheques, there is usually a time gap between the receipt of cheque and deposit of that cheque into the bank account. This time gap is called ‘cheque processing float’.

vi. Cheque Clearing Float:

There is a delay between the time a cheque is deposited and the time the funds are available to be spent. The cheques are processed through the clearing system which takes 2 days, for receipt of funds in spendable form. It is called the ‘cheque clearing float’.

Types of Float:

The float is of three types:

(i) Collection float,

(ii) Payment float and

(iii) Net float.

1. Collection Float:

The term ‘collection float’ means the time between the payment made by the debtors or customers and the time when funds available for use in the company’s bank account. In other words, the amount tied-up in cheques and drafts that have been remitted by the customers to the company but has not converted into cash for use in the company’s operations.

The reasons for the lengthy float are as follows:

(a) The delay or time taken in postal transmission from customer to company’s head office.

(b) The delay in presentation of cheques and drafts into the bank for collection.

(c) The time needed by the bank to clear a cheque.

To reduce the float, the company can adopt the techniques like concentration banking, lock box system, zero balance accounts, computerised cash management services etc., which will improve the efficiency in cash management of a company.

2. Payment Float:

Cheques issued but not paid by the bank at any particular time is called ‘payment float’. The company can make use of the payment float called ‘playing the float’, in the sense that the company can issue cheques, even it means as per books of account an overdrawal beyond permissible bank limits.

The payment float can be used to the advantage of the firm in times of shortage of funds as it helps to stretch resources in times of necessity. But the company should be very cautious in playing the float in view of the stringent provisions regarding dishonour of cheques, loss of reputation etc.

3. Net Float:

The net float at a point of time is simply the overall difference between the firm’s available bank balance and the balance shown by the ledger account of the firm. If the net float is positive, i.e., payment float is more than receipt float, then the available bank balance exceeds the book balance.

A firm with a positive net float can use it to its advantage and maintain a smaller cash balance than it would have in the absence of the float. An efficient cash management requires to accelerate cash collection as much as possible and delay cash disbursements as much as possible.

Management of Float:

The cash management has two basic objectives:

(i) To ensure availability of cash as per payment schedule, and

(ii) To minimize the amount of idle cash balance,

The efficient cash management will aim at maximizing the availability of cash inflows by decentralizing collections and decelerating cash outflows by centralizing disbursements.

The techniques adopted for managing the float are as follows:

1. Accelerating Cash Collections:

When a company receives payments through cheque that arrive by mail, all the three components of collection time are relevant. The Finance Manager should take steps for speedy recovery from debtors and for this purpose proper internal control system should be installed in the firm.

Once the credit sales have been effected, there should be a built-in mechanism for timely recovery from the debtors. Periodic statements should be prepared to show the outstanding bills. Incentives offered to the customers for early/prompt payments should be well communicated to them.

Once the cheques/drafts are received from customers, no delay should be there in depositing these receipts with the banks. The time lag in collection of receivables can be considerably reduced by managing the time taken by postal intermediaries and banks. A large firm operating over vide geographical areas can accelerate its collection by decentralized collection procedure.

Under this system, the firm instead of having single collection centre centralized at head office of the firm, open a large number of collection centres on geographical basis. The objective in this method of cash collections is to minimize lag between the mailing time from customers to the firm and time when the firm can make use of the funds. This system of cash collection will accelerate the cash inflows of the firm.

2. Lock Box System:

Under a lock box system, customers are advised to mail their payments to special post office boxes called ‘lockboxes’, which are attended to by local collecting banks, instead of sending them to corporate headquarters. A lock box arrangement is generally on regional basis which the firm chooses according to its billing patterns customers are billed with instructions to mail their remittances to the lock boxes.

The local bank collects the cheques from the lock box once or more a day, deposits the cheques directly into the local bank account of the firm, and furnishes details to the firm.

Thus the lock box system:

(i) Cuts down the mailing time, because cheques are received at a nearby post office instead of at corporate headquarters,

(ii) Reduces the processing time because the company does not have to open the envelopes and deposit the cheques for collection, and

(iii) Shortens the availability delay because the cheques are typically drawn on local banks.

In India, the lock box system is not popular because of the high cost of its operation. Lock box system may not be profitable if the average remittance is small.

3. Concentration Banking:

A firm may open collection centres (banks) in different parts of the country to save the postal delays. This is known as ‘concentration banking’. Under this system, the collection centres are opened as near to the debtors as possible, hence reducing the time in dispatch, collection etc.

The firm may instruct the customers to mail their payments to a regional collection centre/bank rather than to the central office. The cheque received by the regional collection centre are deposited for collection into a local bank account. Surplus funds from various local bank accounts are transferred regularly (mostly daily) to a concentration account at one of the company’s principal banks.

For effecting the transfer several options are available. With the vast network of branches set up by banks, regional/local collection centres can be easily established. To ensure that the system of collection works according to plan, it is helpful to periodically audit the actual transfers by the collecting banks and see whether they are in conformity with the instructions given.

The concentration banking results in saving of time of collection, and, hence results in better cash management. However, the selection of collection centres must be based on the volume of billing/business in a particular geographical area.

It may be noted that the concentration banking also involve a cost in terms of minimum cash balance required with a bank or in the form of normal minimum cost of maintaining a current account. Concentration banking can be combined with lock box arrangement to ensure that the funds are pooled centrally as quickly as possible.

4. Electronic Fund Transfer:

With the developments took place in the computer technology, the present banking system is also being switched over to the computer network of banks to offer efficient banking services and cash management services to their customers. The network will be linked to the different branches, banks.

This will help the customers in the following ways:

(a) Instant updation of accounts and reporting of account balances, as and when required without any delay.

(b) The transfer of funds will take place very fast and there will be substantial reduction of float.

(c) Information about foreign exchange rates, interest rates, etc. can be easily accessed by the customers.

5. Delaying Payments:

A firm can increase its net float by speeding up collections. It can also increase the net float by delayed disbursement of funds from the bank by increasing the mail time. A company may make payment to its outstation suppliers by a cheque and send it through mail. The delay in transit of cheque and delay in collection of the cheque, will be used to increase the float.

A firm is expected to enjoy full credit period allowed by the suppliers and payment may be delayed as much as possible without affecting the credibility of the firm and its goodwill. The centralized disbursements are recommended to exercise effective control over cash outflows as well as to manage the paying float to the advantage of the firm.

A centralized disbursement system is recommended to exercise effective control over disbursements and to enjoy credit period as much as possible. This is system of payment is also called as ‘playing float’. But this technique is to be exercised with caution without damaging the goodwill of the firm and confidence of the suppliers of materials and services.

Electronic Cash Management System:

Most of the cash management systems in the world are electronically based, since ‘speed’ is the essence of any cash management system. Electronically transfer of data as well as funds play a key role in any cash management system.

Various elements in the process of cash management are linked through a satellite. Various places that are interlinked may be the place where the instrument is collected, the place where cash is to be transferred in company’s account, the place where the payment is to be transferred etc.

Certain networked cash management systems may also provide a very limited access to third parties like parties having very regular dealings of receipts and payments with the company etc. A finance company accepting deposits from public through sub-brokers may give a limited access to sub-brokers to verify the collections made through him for determination of his commission among other things.

Good cash management is a continuous process of knowing:

(i) When, where and how a company’s cash needs will occur.

(ii) Knowing what the best sources for meeting additional cash needs.

(iii) Being prepared to meet the needs when they occur by keeping good relationships with bankers and other creditors.

Benefits:

The benefits arising from electronic cash management system are as follows:

(a) Significant saving in time.

(b) Decrease in interest costs.

(c) Less paper work.

(d) Greater accounting accuracy.

(e) More control over time and funds.

(f) Provides timely access of information.

(g) Enables easy employee related payments.

(h) Supports electronic payments.

(i) Faster transfer of funds from one location to another, where required.

(j) Speedy conversion of various instruments into cash.

(k) Making available funds wherever required, whenever required.

(l) Reduction in the amount of ‘idle float’ to the maximum possible extent.

(m) Ensures no idle funds are placed at any place in the organization.

(n) It makes interbank balancing of funds much easier.

(o) It is a true form of centralized ‘cash management’.

(p) Produces faster electronic reconciliation.

(q) Allows for detection of book-keeping errors.

(r) Reduces the number of cheques issued.

(s) Earns interest income or reduce interest expense.

A parent corporation with subsidiaries worldwide, can pool everything internationally so that the company offset the debts with the surplus monies from various subsidiaries. It will result in transformation of treasury function as a profit-centre by optimizing cash and put it to profitable use.

Creative and proactive cash management solutions can contribute dramatically to a company’s profitability and to its competitive edge. The ultimate purpose of proper management of liquidity, it to improve the overall profitability of organization.

Virtual Banking:

Virtual banking denotes ‘the provision of banking and related services through extensive use of information technology without direct recourse to the bank by the customer’. The origin of virtual banking in the developed countries can be traced back to the seventies with the installation of Automated Teller Machines (ATMs).

Subsequently, driven by the competitive market environment as well as various technological and customer pressures, other types of virtual banking services have grown in prominence throughout the world.

The Reserve Bank of India has been taking a number of initiatives, which will facilitate the active involvement of commercial banks in the sophisticated cash management segment to ensure faster and reliable mobility of funds.

Some of the latest technologies adopted in banking systems are as follows:

(a) Computerised Settlement of Clearing Transactions

(b) Magnetic Ink Character Recognition (MICR) Technology

(c) Inter-City Clearing Facilities

(d) High Value Clearing Facilities

(e) Electronic Clearing Service Scheme (ECSS)

(f) Electronic Funds Transfer (EFT) Scheme

(g) Delivery v. Payment (DvP) for Government Securities Transactions

(h) Setting up of Indian Financial NET-work (INFINET)

(i) Centralized Funds Management System (CFMS)

(j) Securities Services System (SSS)

(k) Real Time Gross Settlement System (RTGS)

(1) Structured Financial Messaging System (SFMS)

Advantages:

The advantages of virtual banking services are as follows:

(i) Lower cost of handling a transaction via the virtual resource compared to the cost of handling the transaction via the branch.

(ii) The increased speed of response to customer requirements under virtual banking vis-a-vis branch banking can enhance customer satisfaction and can lead to higher profits via handling a large number of customers accounts.

(iii) The lower cost of operating branch network along with reduced staff costs leads to cost efficiency under virtual banking.

(iv) Virtual banking allows the possibility of improved equality and an enlarged range of services being available to the customer more rapidly and accurately and at his convenience.

The popularity which virtual banking services have won among customers, owing to the speed, convenience and round the clock access they offer.