Deferred float: Meaning, Criticisms & Real-World Uses

What Is Deferred Float?

Deferred float, in the context of Cash Management, refers to the amount of money that a company or individual has paid out but which has not yet been debited from their bank account. This temporary availability of funds arises due to delays in the Payment System, such as the time it takes for a check to be mailed, processed by the payee, and then cleared through the banking system. Essentially, it represents funds that the payer can still utilize for a brief period, even after initiating a payment.

History and Origin

The concept of float, including deferred float, has been an inherent part of the banking system since the widespread adoption of paper-based payment instruments like checks. In the early and mid-20th century, the physical movement of checks between banks and the manual processes involved in Check Clearing created significant delays. This lag allowed both payers and payees to briefly count the same money in their accounts, leading to various forms of float.

The importance of managing float grew significantly as Interest Rates rose in the 1970s, making the temporary availability of funds more valuable. Corporations began to actively manage their cash to maximize the period during which they could retain funds, often by writing checks on banks located far from the payee to extend the clearing time—a practice known as "remote disbursement". ⁴This led to increased scrutiny from regulatory bodies and spurred efforts to reduce systemic float.

In the United States, legislative actions like the Expedited Funds Availability Act (EFAA) of 1987 and the Check Clearing for the 21st Century Act (Check 21) aimed to reduce the time funds were held by banks, primarily focusing on improving the availability of deposited funds (reducing collection float). The Federal Reserve also undertook initiatives, including the pricing of float under the Monetary Control Act of 1980, to encourage banks to clear checks more efficiently and minimize the system-wide float. ³These efforts, alongside the rise of Electronic Funds Transfer (EFT) and Automated Clearing House (ACH) transactions, have significantly reduced the prevalence and magnitude of deferred float in modern finance.

Key Takeaways

Deferred float represents funds that a payer has committed but that have not yet been debited from their account, typically due to payment processing delays.
It provides the payer with temporary Liquidity, allowing them to use the funds for other purposes for a longer period.
The magnitude of deferred float has diminished substantially with advancements in electronic payments and regulatory changes.
Effective Working Capital Management involves understanding and optimizing deferred float.
While advantageous for the payer, excessive manipulation of deferred float can lead to legal and ethical issues.

Formula and Calculation

Deferred float is primarily a concept describing the time lag rather than a single, universally applied formula like a financial ratio. However, its value can be quantified to understand its impact on a firm's cash position. For a given payment, the value of deferred float can be thought of as the payment amount multiplied by the number of days the funds remain in the payer's account before being debited.

The average daily deferred float can be calculated as:

\text{Average Daily Deferred Float} = \sum_{i=1}^{n} \frac{(\text{Amount of Payment}_i \times \text{Number of Days Deferred}_i)}{\text{Number of Days in Period}}

Where:

(\text{Amount of Payment}_i) = The value of an individual payment initiated.
(\text{Number of Days Deferred}_i) = The number of days between when the payment was initiated (e.g., check written) and when the funds were actually debited from the payer's bank account.
(\text{Number of Days in Period}) = The total number of days over which the average is calculated (e.g., 30 days for a month).

This calculation helps a company's Treasury Management team assess the financial benefit of holding onto funds for longer periods.

Interpreting the Deferred Float

Interpreting deferred float involves understanding its impact on a firm's actual cash position versus its book (ledger) balance. A positive deferred float means that the cash balance in the company's bank account is higher than its internal accounting records indicate, because payments recorded in the books have not yet cleared the bank. This temporary surplus of cash can be significant for businesses managing large volumes of disbursements.

For example, if a company issues a check, its internal accounting system immediately reduces the cash balance. However, the bank account balance remains unchanged until the check is presented and cleared by the payee's bank. During this interval, the company benefits from deferred float, as it retains the use of those funds. This allows for more efficient use of cash, such as keeping funds invested for an extra day or two, thereby generating additional income, or avoiding short-term borrowing. Companies aim to maximize their deferred float within ethical and legal boundaries to optimize their overall cash position and improve their Bank Reconciliation process.

Hypothetical Example

Consider "Alpha Manufacturing," which issues a payment of $50,000 to a supplier via paper check on Monday, July 1st. Internally, Alpha Manufacturing's accounting system reduces its cash balance by $50,000 on July 1st.

July 1st (Monday): Alpha Manufacturing mails the $50,000 check.
July 3rd (Wednesday): The supplier receives the check and deposits it into their bank account.
July 5th (Friday): The check finally clears through the banking system, and the $50,000 is debited from Alpha Manufacturing's Demand Deposit account.

In this scenario, Alpha Manufacturing benefited from deferred float for four days (July 1st, 2nd, 3rd, and 4th, assuming weekend non-processing). For those four days, Alpha Manufacturing's bank balance was $50,000 higher than its book balance, allowing it to retain and potentially earn interest on these funds for an extended period. If Alpha Manufacturing had invested these funds overnight at a rate of 5% annually, even a few days of deferred float could result in a small but tangible financial benefit.

Practical Applications

Deferred float plays a role in several aspects of financial operations, particularly in corporate Treasury Management.

Cash Flow Optimization: Companies strategically manage their disbursements to maximize deferred float, thereby extending the time they have access to their cash. This means scheduling payments effectively, often using payment methods that naturally incur some processing delay, such as paper checks, where appropriate and within payment terms.
Investment Income: The funds represented by deferred float can be kept in interest-bearing accounts or short-term investments for a longer duration, generating additional investment income for the firm. This is especially relevant for large corporations with substantial daily payment volumes.
Liquidity Management: By extending the period during which funds remain in the company's account, deferred float provides an additional cushion of Liquidity. This can help avoid the need for costly short-term borrowing to cover temporary cash shortages.
Working Capital Management: Deferred float is a critical component of Working Capital Management, influencing the cash conversion cycle. By extending the period of disbursement, a firm can reduce its net investment in working capital. The Kennesaw State University study on the cost of float highlights how understanding and managing float can enhance the value of a firm's operating activities.
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Limitations and Criticisms

While beneficial for the payer, deferred float presents certain limitations and criticisms:

Reduced Predictability: The exact timing of check clearing can be unpredictable due to various factors like mail delays, recipient processing times, and bank holidays. This uncertainty makes it challenging to precisely forecast the duration of deferred float, complicating precise Cash Management and Bank Reconciliation.
Ethical and Legal Concerns: Aggressive strategies to artificially inflate deferred float, such as intentionally delaying check mailing or drawing checks on distant banks (remote disbursement), can be viewed as ethically questionable or even illegal if they involve defrauding banks or suppliers. A notable historical example is the E.F. Hutton scandal in the 1980s, where the brokerage firm pleaded guilty to charges of deliberately overdrawing bank accounts to profit from the float, essentially using bank funds without authorization or interest payments.
Diminishing Returns: With the increasing adoption of electronic payment methods like Wire Transfers, Automated Clearing House (ACH) transfers, and real-time payment systems such as FedNow, the opportunities to generate significant deferred float are rapidly shrinking. These faster payment systems reduce or eliminate the time lag inherent in traditional paper-based transactions. The Federal Reserve continues to promote initiatives for faster payments, further reducing the scope for deferred float.
¹* Operational Complexity: Actively managing deferred float can add complexity to a firm's accounting and treasury operations. It requires meticulous tracking of payment initiation dates versus bank clearing dates.

Deferred Float vs. Availability Float

Deferred float and Availability Float are both components of the broader concept of "float" in banking, but they represent opposite sides of a payment transaction.

Deferred Float refers to the funds that remain in the payer's bank account after a payment has been initiated but before the funds are actually debited by the bank. It represents a temporary increase in the payer's available cash balance compared to their ledger balance. The payer benefits from this float by retaining control over the funds for a longer period.

Availability Float, conversely, refers to the funds that have been deposited into the payee's bank account but are not yet available for withdrawal or use by the payee. While the payee's bank may provisionally credit their account, the funds are not "collected" until the check clears the payer's bank. The payee is temporarily deprived of the immediate use of these funds. Banks impose availability schedules, governed by regulations like the Expedited Funds Availability Act, to specify when deposited funds become usable.

The confusion between the two often arises because both involve a time lag in the Payment System. However, deferred float benefits the payer, allowing them to defer the actual outflow of cash, while availability float impacts the payee, delaying their access to incoming funds.

FAQs

How do electronic payments affect deferred float?

Electronic payments, such as Wire Transfers and Automated Clearing House (ACH) transactions, significantly reduce or eliminate deferred float. Unlike paper checks, these methods typically result in faster settlement, meaning funds are debited from the payer's account much more quickly, sometimes even instantly.

Is deferred float legal?

Yes, deferred float is a natural outcome of payment processing delays and is generally legal. However, attempts to artificially create or excessively manipulate deferred float through deceptive or fraudulent practices (e.g., check kiting, deliberate remote disbursement to defraud) are illegal and can lead to severe penalties.

Why is deferred float important for businesses?

Deferred float is important for businesses as it allows them to temporarily retain and utilize funds that have been committed for payment. This can improve a company's Liquidity position, provide opportunities for short-term investment income, and enhance overall Cash Management efficiency.

Does deferred float impact a country's money supply?

Yes, float, including deferred float, can briefly inflate the measurement of a nation's money supply because the same money is temporarily counted in two different accounts. The Federal Reserve monitors and accounts for float in its Monetary Policy operations.