Creative Kitchen Corporation (CKC) was founded 25 years ago by its president Percy Cook. The company originally began as mail-order company, but has grown rapidly in recent years, in large part due to its user-friendly website. Due to the large geographic range of the company’s customers, it currently employs a lockbox system with collection centres in Surrey, Winnipeg, Ottawa, and Quebec City. On average, each lockbox centre handles $193,000 in payments each day. The company’s current policy is to invest these payments in short-term marketable securities daily at the collection centre banks. Every two weeks, the investment accounts are swept; the proceeds are wire-transferred to CKC’s headquarters in Edmonton to meet the company’s payroll. The investment accounts each earn 0.012% per day, and the wire transfers cost 0.20% of the amount transferred. You are the company’s Financial Controller. You have recently been approached by the Royal Canadian Bank about the possibility of setting up a concentration banking system for Creative Kitchen Corporation. Royal Canadian will accept each of the lockbox centre’s daily payments via automated clearinghouse (ACH) transfers in lieu of wire transfers. The ACH-transferred funds will not be available for use for one day. Once cleared, the funds will be deposited in a short-term account, which will also yield 0.012% per day. Each ACH transfer will cost $150. Percy has asked you for a meeting to discuss the cash collection policies and which cash management system will be the best for the company. To prepare for the meeting, Percy has asked you to determine the cost of ACH transfers that would make the company indifferent between the two systems.
Creative Kitchen Corporation (CKC) is a thriving company founded by Percy Cook 25 years ago. Initially starting as a mail-order company, CKC has seen rapid growth in recent years, thanks in large part to its user-friendly website. To manage its cash flow effectively, CKC employs a lockbox system with collection centers in various locations. Percy Cook, the President of CKC, is now exploring the possibility of transitioning to a concentration banking system offered by the Royal Canadian Bank. In this essay, we will evaluate the cash collection policies of CKC and determine the cost of ACH transfers that would make the company indifferent between the two systems.
CKC’s current cash management system involves using lockbox centers in Surrey, Winnipeg, Ottawa, and Quebec City to handle an average of $193,000 in payments each day. The company invests these payments in short-term marketable securities at the collection center banks daily. Every two weeks, the investment accounts are swept and the proceeds are wire-transferred to CKC’s headquarters in Edmonton to meet the company’s payroll. The investment accounts earn 0.012% per day, and the wire transfers incur a cost of 0.20% of the amount transferred.
The Royal Canadian Bank has proposed an alternative approach to cash collection. They would accept the daily payments from CKC’s lockbox centers via Automated Clearinghouse (ACH) transfers instead of wire transfers. The ACH-transferred funds would not be available for use for one day and would then be deposited in a short-term account, yielding 0.012% per day. Each ACH transfer would incur a cost of $150.
To determine the cost of ACH transfers that would make CKC indifferent between the two systems, we need to compare the costs of the current system to the proposed concentration banking system. Let’s break down the costs and benefits of each system:
Current System:
Daily investment return: 0.012% on $193,000
Investment income per day = 0.012% * $193,000 = $23.16
Bi-weekly wire transfer cost: 0.20% on the transferred amount
Wire transfer cost per bi-weekly sweep = 0.20% * (2 * $193,000) = $772
Proposed Concentration Banking System:
Daily ACH transfer cost: $150
Daily investment return: 0.012% on $193,000 (delayed by one day)
Investment income per day = 0.012% * $193,000 = $23.16
Total daily cost = Daily ACH transfer cost + Investment income foregone = $150 + $23.16 = $173.16
Comparison and Conclusion: To make CKC indifferent between the two systems, the total cost of the proposed concentration banking system should not exceed the total cost of the current system. Therefore, the cost of ACH transfers that would make CKC indifferent is $772 per bi-weekly sweep, which is the same as the cost incurred in the current system.
In conclusion, the concentration banking system offered by the Royal Canadian Bank can be considered cost-effective for CKC if the cost of ACH transfers remains below $772 per bi-weekly sweep. This change would not only reduce the company’s cash management expenses but also offer a more efficient and streamlined process for managing cash flows. Percy Cook and the CKC management should carefully evaluate this option to ensure it aligns with the company’s financial objectives and strategies.
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