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Tapping cash flow yields profits.

In these times of declining returns, real estate professionals are placing particular emphasis upon increased efficiency and the realization of additional revenues in the management of assets. Property tax appeals, utility audits, and rebidding of service contracts are among the very visible signs of this trend.

One often-overlooked area with potential for increasing income is the art and science of cash management.

Cash management tends to be overlooked in the management of real estate assets because the returns available may not, at first glance, appear dramatic; the multiple separate bank accounts used in real estate make the needed data collection cumbersome; and the concept of cash management is sometimes distorted by a misunderstanding of the true costs of certain bank services.

This article will explain the elements which comprise cash management in a general sense, and offer a discussion of particular difficulties of cash management within the concept of property management.

What is cash management?

The first step in the standard cash management process, which was originally developed for manufacturing companies, is redesigning a company's bank account structure. Years ago, a typical company had many bank accounts, usually scattered around various banks.

With the advent of professional cash management, the operative word became "consolidate." Funds were merged into a limited number of bank accounts to allow more control over monies.

Effective cash management is absolutely dependent on knowledge of the status of cash balances and near-term cash flows at all times. Daily bank reports are an important part of this control process, and it is necessary to keep these reports concise and useful.

Once a bank account structure is in manageable form, the cash management process can be summarized as:

* Collecting cash receipts as quickly as possible.

* Paying bills as slowly as practical.

* Investing excess cash.

Speeding cash collections

Collecting cash quickly is a function of working hard on collecting receivables and getting the receipts into the bank promptly. The attention to receivables is an extremely important part of cash management, but it has been well covered in previous articles. (See "Boosting Net Operating Income," Wirta, JPM, September/October 1991.)

The bank lockbox is a well-established tool for getting cash into the bank account a day or two earlier than if the receipts were collected in-house. (Many times a good bit of the time gained comes from leaving a sloppy internal system where receipts are not always opened and deposited expeditiously.)

A bank lockbox also moves a clerical function from the management company to the bank. Because the cost of bank clerical functions is borne by investors, real savings in salary cost may be achieved by using a lockbox service.

However, speeding up the deposit of cash into banks will have a positive effect on earnings only if that cash is invested immediately on receipt. Depositing cash early cannot justify the cost of a lockbox if that cash just sits in a checking account for a couple of weeks until it is used to cover disbursements.

Slowing down disbursements

If there are benefits in early collection, there is also a value to later disbursement. Certain companies with large cash flows will find it economically attractive to employ the "remote disbursement" strategy of paying. For example, West Coast vendors can employ East Coast banks in order to extend the length of time it takes a disbursement check to clear the bank account.

Others will find it beneficial to use the services of a bank that lets them hold off funding checks until the day that they clear the bank.

The pricing on these disbursement services will make them most attractive to the large user. For those who wish to keep it simpler, factoring the value of money into the disbursement pattern may still result in the delay of some disbursements.

Very often a disbursement pattern is set with an eye toward spreading out the workload of the accounting department. While that may be a valid factor, new and improved "payables" systems should give the company more room to set disbursements as late as is practical.

Investing funds

As mentioned earlier, most cash management strategies are based on the presumption that cash can be put to work. Central to the investing decision is the process of analyzing data--bank balances, disbursement schedules, and so forth--in order to get a handle on the present and near-term cash situation and make the right investment decision.

Once the amount available for investment is determined, several alternatives are open to the cash manager:

* Investing in a bank money market account.

* Using a bank "sweep" account.

* Buying mutual funds.

* Investing in overnight funds or instruments with short maturities, such as Treasury bills, commercial paper, or CDs.

The size of the potential investment will be the factor that determines which of these options makes sense. Anyone with potential investments in amounts greater than $100,000 will have their choice from the list above.

On the other hand, investors with smaller amounts to invest will be constrained in their choices. They will probably be limited to the instruments which are offered by the bank where their checking account is located. Many banks do not offer mutual-fund investments or "sweep accounts." With smaller amounts, the cost of a wire transfer to make payment in another bank will probably have a detrimental effect on the earnings rate.

Once a vehicle is chosen, the decision will be determined by the earnings rates, the length of time that the cash is available for investment, and the security risk acceptable to the investor.

Complying with required balances

The objective of the cash management department in any bank is to provide the bank with fee income. Investment accounts are but one of many services offered by banks in order to generate that income. It is important to understand how the banks are compensated for those services.

In almost all cases, banks want to be compensated by having the customer leave enough unused and uninvested collected balances in the bank account to pay for services. The calculation that matches required balances against the provided services can be found in a bank-generated document generically referred to as an "account analysis."

The format of this document will be a variation of the following:
For January:
Number of units of
service provided 200
Times price per unit $0.27
Total price of
services provided $54.00
Average amount of
balances for January $60,000
Times monthly
earnings factor 0.23%
Earnings on balances
to pay for services $138.00
Profit on account $84.00

These documents should be provided on request by the bank. The formats vary, but the principle of capitalizing a cost to a dollar balance using an earnings factor is common to all. Several points should be considered:

* The bank has already put a profit margin into the price of the service, so a "profit on account" of zero is still profitable to the bank.

* A negative "profit on account" is not disastrous. The bank will simply charge your account for the shortfall. In fact, if cash can be put to work at rates greater than the earnings factor (not a difficult feat), overall earnings will increase if a company is in a shortfall situation. Most companies should simply manage the checking accounts and investments at the levels that are economic and let the paying-for-services chips fall where they may.

* Bank services should never be considered "free" just because the company does not feel that it has any other use for the cash. This will be tempting at times, but it may preclude eventual earnings possibilities.

Adapting cash management for property management

The cash flow pattern of most properties tends to follow regular monthly patterns that are conducive to cash management and investing. Rents are collected at the beginning of the month, and the cash generally is not used until the end of the month. This means that there usually is a cash bulge in the middle of the month.

Figure 1 represents a typical bank account. Note that, depending on the timing of the rent collections and the check runs, the average daily balance will equal a fairly high percentage of the monthly rents.

In this example, we see an account that barely covers the month-end debt service. However, the amount equal to the shaded area is still available to invest, and, if the rates go up to about 5 percent, the annual investment income should be about 3 percent of the monthly rents.

Management considerations for cash management

Yet, there are problems in applying cash management techniques to real estate management. Managers who are considering cash management must be certain that the management agreements specifically state that they have the right to invest owners' funds and to combine the funds from several properties for investment purposes.

Any agreement should also specify that the manager is not liable if investments are not profitable. It also may be advisable to check with an attorney to determine whether a securities license is necessary to invest funds for others.

The management agreement should also state specifically if and in what amounts or percentages the property manager will be compensated for cash management work. Third-party managers are generally compensated on property performance. While they may have "soft" incentives to provide extra service, they usually have no monetary incentives to manage cash, as the profits would go directly to the owner.

Another overriding problem faced by most property managers when considering cash management is the large number of individual bank accounts that must be managed. Often managers cannot consolidate bank accounts for fiduciary reasons or for ease of tax and partnership reporting. Thus, the basic process of reviewing bank and accounting data for each account becomes almost exponentially more difficult.

This inability to consolidate accounts means that each discrete bank account and potential investment will be smaller. Because the investment payoffs per account will be smaller, the techniques used to manage accounts will have to be more efficient.

Some owners and managers deposit receipts into parallel money market accounts and then fund one or two check runs a month from that fund. This strategy is efficient, but it still requires that the manager have good control over the bank accounts. The number of movements in or out of a bank money market fund is often limited by bank policy, and without control and cash foresight, the manager could end up losing earnings.

Taking a clue from techniques developed in industries that monitor huge volumes of daily bank data, an innovative information system has been developed by some software vendors to receive data from the bank not as printed reports but as raw data downloaded electronically to a PC. There it may be sorted into those accounts that require attention using criteria set by the manager to establish action points.

Such systems also may include supporting data on the outstanding investments, disbursement requirements, and so forth to let the manager make a quick, informed investment decision. In this manner, the cash may be invested with minimal manpower, due to efficient organization of data as well as predetermined investment criteria.

Such a system will not only benefit the owners and real estate advisors who already are working to create effective cash management; it also will be of potential value to the fee manager. If the manager has the potential to lower the cost of managing cash, there is additional motivation to add this service to the list of those already being offered.

Cash management techniques will not save a troubled property, instantly restore a real estate firm to profitability, or make the cash manager the most popular member of a company. Yet, these techniques are one important element in an increasingly sophisticated approach to optimizing our real estate assets.

Richard Bruning is president of BACA Systems, a software development and consulting company specializing in cash-flow management. He previously was assistant treasurer at Transamerica Corporation, treasurer at United Artists Corporation, and CFO at United Satellite Communications, Inc. His undergraduate degree is from Yale.

Richard Lucy has had a 17-year career in commercial real estate. Originally a broker with Coldwell Banker in Los Angeles, he moved to development, property management, and workouts, and is now managing director with the Advisory Service Group of The Seeley Company in Los Angeles. He holds a B.S. degree from Massachusetts Institute of Technology.

Mr. Bruning and Mr. Lucy were classmates at the Harvard Business School.
COPYRIGHT 1993 National Association of Realtors
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993 Gale, Cengage Learning. All rights reserved.

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Author:Bruning, Richard; Lucy, Richard
Publication:Journal of Property Management
Date:Mar 1, 1993
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