Cash float refers to the total sum of checks written or received by an individual or entity that have not yet been debited from or credited to their bank account. Essentially, it represents the time lag between when a transaction occurs and when the corresponding funds are actually available or withdrawn from a bank account. This timing difference arises due to the various processes involved in clearing checks through the banking system.
Understanding the Concept of Float
The concept of cash float is crucial for effective cash management, particularly for businesses. It highlights that the balance shown in your internal records might differ from the actual cash available in your bank account at any given moment. This discrepancy is temporary and resolves once checks clear, but understanding it allows for better financial planning and optimization of cash resources.
The primary reason for cash float is the check clearing process. When a check is written or deposited, it takes time for the funds to move from one bank account to another. This involves several steps, including the payee depositing the check, the bank processing it, and the funds being transferred between financial institutions.
Types of Cash Float
Cash float can be categorized based on whether it benefits the payer or the payee, with the difference between these two types defining the net impact.
Collection Float
Collection float occurs when you receive a check, but the funds are not yet available in your bank account. This type of float effectively ties up your incoming cash, as you cannot use the money until the check clears.
- Example: A business deposits a $5,000 check from a customer. Until the bank processes and clears the check, which might take a day or two, that $5,000 is part of the business's collection float. The business's internal records show an increase in cash, but the bank balance has not yet caught up.
Disbursement Float
Disbursement float occurs when you write a check, but the funds have not yet been debited from your bank account. This type of float allows you to keep your cash for a longer period, as the money remains in your account until the payee deposits the check and it clears.
- Example: A company writes a $10,000 check to a supplier. The funds for this payment remain in the company's bank account until the supplier deposits the check and the bank completes the clearing process. During this period, the $10,000 is part of the company's disbursement float.
Net Float
Net float is the difference between disbursement float and collection float. It indicates the overall impact of float on a company's cash position.
- Formula: Net Float = Disbursement Float - Collection Float
- Significance:
- A positive net float (disbursement float > collection float) means that on average, a company has more cash available in its bank account than its internal records might reflect, offering a temporary boost to liquidity.
- A negative net float (collection float > disbursement float) indicates that a company's available bank balance is less than what its internal records suggest, potentially leading to liquidity challenges if not managed carefully.
| Type of Float | Description | Impact on Cash Availability |
|---|---|---|
| Collection Float | Funds received (via check) not yet credited to your account. | Reduces immediately available cash |
| Disbursement Float | Funds paid out (via check) not yet debited from your account. | Increases immediately available cash |
| Net Float | The difference between disbursement float and collection float. | Overall temporary liquidity position |
Why is Cash Float Important for Businesses?
Understanding and managing cash float is vital for several reasons:
- Cash Flow Management: It provides a more accurate picture of a company's true cash position at any given moment, preventing unexpected shortfalls or identifying surplus cash.
- Liquidity Optimization: By strategically managing float, businesses can maximize the amount of time they hold onto their cash, allowing for better investment opportunities or simply ensuring funds are available when needed.
- Risk Mitigation: Proper float management helps prevent overdrafts and associated fees by ensuring sufficient funds are in the account when checks finally clear.
Managing Cash Float Effectively
While float is an inherent part of the check-based payment system, businesses can implement strategies to manage it to their advantage:
- Strategies to Reduce Collection Float: Aim to convert incoming checks into usable cash as quickly as possible.
- Encourage Electronic Payments: Promote the use of Automated Clearing House (ACH) transfers, wire transfers, credit card payments, or online payment platforms, which typically clear much faster than checks.
- Remote Deposit Capture (RDC): Utilize RDC technology to deposit checks electronically from your office, reducing mail time and physical bank visits.
- Lockbox Systems: For businesses receiving a high volume of checks, a lockbox service allows customers to send payments directly to a bank-managed post office box, where the bank collects and deposits the funds quickly.
- Strategies to Manage Disbursement Float: While the goal isn't to delay payments unfairly, strategic management can optimize cash utilization.
- Strategic Payment Timing: If using checks, mail payments closer to their due dates, considering typical mail and clearing times.
- Utilize Electronic Payments Wisely: While electronic payments reduce your own disbursement float, they also reduce your collection float from customers. It's about balancing the two. For some large, strategic payments, a check might offer a slight float advantage.
Practical Insights
In today's digital age, with the increasing adoption of electronic payments and faster check clearing processes, the significance of cash float, particularly for everyday transactions, has diminished for many individuals and smaller businesses. However, for large corporations dealing with numerous and substantial check transactions, managing cash float remains a critical aspect of efficient treasury operations. It's important to remember that managing float is a legitimate financial practice aimed at optimizing cash flow, not a means of avoiding financial obligations.
