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Playing The Float

Float Management Assignment / Homework Help
Float plays an important role in cash management. The cash balance as per the company’s records may not always be the same as the bank balance available. The difference between both the balances is called as the Net float. When the company has issued many cheques that are awaiting clearance, the available balance will be larger than the ledger balance. Similarly when the company has deposited many cheques that are yet to be collected by the bank, the available balance will be smaller. The company can take advantage of the smaller cash balance available if it expects a little longer time for its issued cheques to get cleared. This is called as playing the float. Firms can manage the float by speeding up collections and slowing down payments.

Types of Float:
  • Disbursement float - The amount of cheque issued but not presented for payment is known as disbursement float.

    Example:
    Let us assume that X Ltd. has a ledger balance and bank available balance of $100,000 as on 1st March. On 2nd March, it issues a cheque for $30,000 to one of its suppliers. This consequently reduces the ledger balance to $70,000. The bank, however, will not debit X Ltd. till the cheque is presented for payment. Say, the suppliers present the cheque on 7th March only. So, till this happens, the available balance is greater than the book balance by $30,000.

    Disbursement float = Company's available bank balance – Company's ledger balance
    => $100,000 - $70,000 => $30,000.
  • Collection Float - The amount of cheque deposited in the bank, but not yet collected is called as the collection float.

    Example:
    Let us assume that X Ltd. has a ledger balance and bank available balance of $100,000 as on 1st March. On 2nd March, it receives a cheque for $20,000 from one of its accounts receivables. This will increase the ledger balance by $20,000. But this amount will not be available to the company till its bank presents the cheque for collection. Say, the cheque is collected on 7th March. So, between those periods, the available balance will be lower than the book balance by $20,000.

    Collection float = Company’s available bank balance – Company’s ledger balance
    => $100,000 - $120,000 => ($20,000)
Net Float

The overall difference between the available balance in bank account and the company’s book balance is called as the net float.

If Disbursement float > Collection float, then Net float is positive. The available bank balance exceeds the book balance.

If Disbursement float < Collection float, then Net float is negative. The available bank balance will be lower than the book balance.

If the company has a positive net float, it may issue more cheque amounts, even though the balance as per its book is lower.

So, a company that has a positive net float at a point of time can effectively use and manage the float in such a way that it can maintain a smaller cash balance.


Example:

In the above two cases, X Ltd. Net flows would be:

Net float = $30,000 - $20,000 => $10,000. This net float is positive because the disbursement float of $30,000 is more than collection float of $20,000.

Thus, by properly managing the float, the finance manager can avoid stagnant money that will be otherwise tied up. To manage the float effectively, collections have to be speeded up and disbursements should be delayed.

Speeding up of collections:

The financial or the collection manager has to send timely invoices and outstanding statements so that there is no delay in payments. Also, discounts should be given and early payment should be encouraged. After the receipt of the cheque, steps should be immediately taken to deposit it in the bank without any unnecessary delay.
To speed up collections, companies may use Lock-box system or concentration banking.

Lock-box system: Under this system, firms hire a post office lock-box at important collection centres. Lockbox system is a collection procedure in which payers send their payments/cheques to a nearby post box that is emptied by the firm’s bank several times and the bank deposits the cheque in the firm’s account. It reduces the float by shortening the lethargy as well as postal and bank floats. Postal float is the delay between the time when payer mails a payment and the time when the payee receives it. Lethargy/processing float is the delay between the receipt of a cheque by the payee and its deposit in the account.

Concentration Banking: It is a collection procedure in which payments are made to regionally dispersed collection centres, and then deposited in local banks for quick clearing. It reduces float by shortening the postal and bank float.


Slowing disbursements:
The operating cash requirement can be reduced by slow disbursements of accounts payable. It represents a source of funds requiring no interest payments. The techniques to delay the payments of accounts payable are:
  • Avoidance of early payments – the firm can decide the make the payment on the last date of credit period, in the absence of any trade discounts. If cash discounts exist for earlier payments, it can take advantage of them because the cost of not taking discounts may work out more than benefit of delaying payments.
  • Centralized disbursements – All payments can be made by the head office from a centralized disbursement account which would enable the firm to delay payments and conserve cash. The benefits of this method include increase in transit time which delays payments and a smaller minimum cash balance requirement which is sufficient to be maintained in the centralized bank account, as otherwise, each branch making payments needs to maintain separate minimum cash balance in their respective branch bank accounts.
  • Float - Float used in this context is called as cheque kiting, which is a method of consciously anticipating the resulting float or delay associated with the payment process using it to keep funds in an interest-earning form for as long as possible. The ways of doing it are a) paying from a distant bank b) scientifically cheque-cashing analysis.
  • Accruals – Another important tool for delaying the accounts payable is accruals which are defined as current liabilities that represent a service or goods received by a firm but not yet paid for.

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