Assume that a firm is evaluating whether to establish a lockbox system. The following information is available to make the decision:
-The bank will charge $25,000 per year for the process and the firm will save approximately $8,000 in internal processing costs. Therefore, the estimated net additional cost of processing the receipts is $17,000 ($25,000 - $8,000)
- The float for cash receipts will be reduced by an estimated two days. Therefore, the firm will receive use of the cash receipts on the average two days earlier
- Average daily cash receipts are equal to $300,000 and short term interest costs are 4%
Should the firm establish the lockbox system?
Based solely on cash flow considerations, the firm should establish the system if the interest savings is greater than the increased costs.
In this case, the amount of interest savings is measured by multiplying the increase in average funds, $600,000 ($300,000 per day * 2 days), by the interest costs 4%.
The firm will save an estimated $24,000 ($600,000 * 4%) in annual interest cost.
Therefore , the cost savings for the lockbox system is estimated to be $7,000, the savings in interest cost less the net increase in processing costs ($24,000 - $17,000).
The real benefit may be even greater, because of the intangible value of the increase in internal control from having the bank process cash receipts.
This reduces the firms business risk.