Disbursement float

What Is Disbursement Float?

Disbursement float refers to the period of time between when a company or individual writes a check or initiates a payment, and when the funds are actually debited from their bank account. It is a component of cash management, representing money that the payer still has access to, or can earn interest income on, even after issuing a payment instruction. This concept arises from the time delays inherent in the payment processing system, particularly with paper-based transactions like checks.

In essence, disbursement float provides a temporary increase in a firm's book balance compared to its bank balance. For businesses, managing disbursement float effectively can optimize working capital by allowing funds to remain in interest-bearing accounts for a longer duration. This practice is a key consideration within treasury operations.

History and Origin

The concept of disbursement float gained prominence with the widespread use of paper checks as a primary method of payment. In the early 20th century, and well into the latter half, the process of check clearing involved physical transportation of checks between banks, leading to significant delays. These delays created the "float" phenomenon, where funds could be counted in two places simultaneously: in the payer's account and the payee's account, until the check fully cleared and funds were debited from the payer.

During periods of high interest rates, businesses actively managed disbursement float to maximize the time their funds remained in their accounts, a practice sometimes referred to as "remote disbursement." This involved writing checks on banks located geographically distant from the payee's bank, thereby extending the time it took for the checks to clear. The Federal Reserve, which plays a crucial role in the payments system, saw float increase significantly in the late 1970s, partly due to these cash management practices and rising interest rates⁶. This led to congressional pressure and ultimately the Monetary Control Act of 1980 (MCA-80), which aimed to reduce float by improving the efficiency of the check collection system⁵,⁴. The evolution of payment systems, including the introduction and widespread adoption of electronic funds transfer (EFT) methods, has significantly reduced the prevalence and duration of disbursement float over time.

Key Takeaways

• Disbursement float is the time delay between issuing a payment and the funds leaving the payer's account.
• It primarily occurs with paper-based payments, such as checks, due to processing and transportation times.
• Effective management of disbursement float allows businesses to retain funds longer, potentially earning additional interest income.
• The rise of electronic payment methods has significantly diminished the significance of disbursement float in modern finance.
• Misuse of disbursement float can lead to serious legal consequences, as seen in historical cases of bank fraud.

Formula and Calculation

Disbursement float is typically measured in terms of the average daily dollar amount of checks outstanding. While there isn't a universally applied formula for "disbursement float" as a singular value, its impact is understood by comparing the book balance and the bank balance.

A company's available bank balance generally differs from its book (or ledger) balance due to outstanding checks and deposits in transit. Disbursement float contributes to this difference.

The value of disbursement float can be conceptualized as:

$\text{Disbursement Float Value} = \text{Average Daily Value of Checks Outstanding} \times \text{Average Days to Clear}$

For example, if a company has an average of $100,000 in checks outstanding each day, and it takes an average of 3 days for those checks to clear, the effective disbursement float is $300,000. This indicates that on any given day, the company has access to, or has not yet paid out, $300,000 that has been "spent" on its internal accounting records.

Businesses often monitor this by comparing their internal cash records with their bank statements through a process called bank reconciliation.

Interpreting the Disbursement Float

Interpreting disbursement float involves understanding the temporal difference between a company's internal cash records and its actual cash position at its financial institutions. A positive disbursement float means the company's recorded cash balance (on its books) is lower than its actual cash balance in the bank. This is a favorable position, as it indicates the company retains funds for a longer period.

Conversely, a negative disbursement float, or a "collection float," means funds have been received on the books but not yet cleared in the bank. For treasury professionals, a healthy disbursement float implies efficient cash utilization, where payments are made but the cash outflow is delayed, enhancing the company's overall liquidity. The goal is generally to maximize disbursement float while minimizing collection float to optimize cash on hand.

Hypothetical Example

Consider "Alpha Manufacturing," a company that typically pays its suppliers via paper checks. On Monday, Alpha Manufacturing writes checks totaling $50,000 to various suppliers. On Alpha's internal accounting records, the cash balance is immediately reduced by $50,000. However, these checks are mailed and take several days to reach the suppliers, be deposited, and clear through the banking system.

• Monday: Checks written for $50,000. Alpha's book balance decreases by $50,000. Bank balance remains unchanged. Disbursement float = $50,000.
• Tuesday: Checks are in transit. Alpha's bank balance remains unchanged. Disbursement float = $50,000.
• Wednesday: Some checks totaling $20,000 are deposited by suppliers and begin to clear. Alpha's bank balance is still unchanged as the funds haven't yet been debited. Disbursement float = $50,000.
• Thursday: The $20,000 worth of checks clear Alpha's bank account. Alpha's bank balance decreases by $20,000. The remaining $30,000 in checks are still outstanding. Disbursement float = $30,000.

Until all $50,000 in checks have been debited from Alpha's bank account, the company benefits from disbursement float, retaining those funds for a longer period. This allows Alpha to potentially invest those funds in short-term instruments or use them for other immediate needs before they are finally disbursed.

Practical Applications

While the impact of disbursement float has diminished with the advent of digital payments, it still holds relevance in certain contexts, particularly for businesses that rely on check payments or operate in regions with less developed payment infrastructures.

1. Cash Management Optimization: For companies, strategically managing disbursement float means delaying the actual outflow of funds as long as possible without incurring penalties or damaging vendor relationships. This allows them to maximize the time funds remain in their accounts, potentially earning interest or being used for other purposes.
2. Working Capital Improvement: By extending the period funds are available, disbursement float can temporarily enhance a company's working capital position, providing greater financial flexibility.
3. Monetary Policy Considerations: Historically, the aggregate amount of float in the banking system, particularly "Federal Reserve float," was a factor for central banks in managing the money supply and implementing monetary policy. Significant fluctuations in float could impact bank reserves³.
4. International Payments: In international trade, where payment clearing times can be longer due to different banking systems and regulations, managing disbursement float remains a consideration for multinational corporations to optimize global treasury operations².
5. Risk Management: Understanding disbursement float helps businesses manage the timing of their cash flows more accurately, reducing the risk of unexpected overdrafts or shortfalls.

Limitations and Criticisms

Despite its potential benefits for a payer, the strategic manipulation of disbursement float has significant limitations and has faced criticism:

• Ethical and Legal Concerns: Aggressive or intentional over-utilization of disbursement float, particularly through practices like "check kiting" (writing checks against uncollected funds), is illegal and can lead to severe penalties. A notable example is the E.F. Hutton scandal in the 1980s, where the brokerage firm pleaded guilty to 2,000 counts of mail and wire fraud for intentionally overdrawing accounts to profit from float.
• Impact of Electronic Payments: The dramatic shift from paper checks to electronic payment methods, such as Automated Clearing House (ACH) transfers, wire transfers, and real-time payment systems, has significantly reduced the time delays that create disbursement float. This makes the practice less relevant and less impactful for most modern businesses¹.
• Relationship Damage: Deliberately delaying payments to maximize float can strain relationships with suppliers and vendors, potentially leading to late payment fees, unfavorable terms, or even refusal to do business.
• Unpredictability: Float can be unpredictable due to factors like holidays, weather, and bank processing efficiencies. Relying too heavily on float for cash management can lead to miscalculations and liquidity issues.
• Reduced Opportunities: As the average clearing time for payments decreases, the opportunity for exploiting disbursement float for financial gain shrinks considerably, rendering it a minor consideration for sophisticated cash management strategies.

Disbursement Float vs. Collection Float

Disbursement float and collection float are two sides of the same coin within the broader concept of "float." The key distinction lies in whose perspective the float is viewed from, and consequently, whether it represents a benefit or a cost.

While disbursement float benefits the payer by extending the use of funds, collection float burdens the payee by delaying the availability of received funds. Effective cash management aims to maximize disbursement float while simultaneously minimizing collection float.

FAQs

What is the primary cause of disbursement float?

The primary cause of disbursement float is the time delay inherent in the payment system, particularly with paper checks. This delay includes the time for a check to travel through mail, be deposited by the payee, and then clear through the banking system before funds are officially debited from the payer's account.

Why is disbursement float less significant today?

Disbursement float is less significant today due to the widespread adoption of electronic payment methods such as Automated Clearing House (ACH) transfers, wire transfers, and debit card transactions. These methods significantly reduce or eliminate the time lags associated with physical check processing, making funds available much faster.

Is it legal to use disbursement float to a company's advantage?

Yes, it is generally legal for companies to manage their cash flow efficiently by taking advantage of the natural delays in the payment system. This is a common practice in cash management. However, intentionally manipulating the system through fraudulent activities, such as writing checks without sufficient funds with no intent for them to clear, is illegal and constitutes bank fraud.

How does a company measure its disbursement float?

A company can measure its disbursement float by comparing its book (internal ledger) cash balance with its bank's available cash balance. The difference, primarily attributable to outstanding checks that have been written but not yet cleared, represents the disbursement float. This reconciliation is a key part of financial accounting.