Fundamental Principles of Public Finance Managing Funds Cash Management and Employment Retirement Funds Troy

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Fundamental Principles of Public Finance Managing Funds Cash Management and Employment Retirement Funds Troy Powered By Docstoc
					     Managing Funds:
  Cash Management and
Employment Retirement Funds

          Troy University
  PA6650- Governmental Budgeting
            Chapter 16
• Why should governments have funds to
  invest…does that mean that you were

• Shouldn’t the presence of extra money
  signal that tax cuts are needed?

• There are justifiable reasons to have cash
          The Cash Budget and
           Cash Management
• Short term handling of working capital to
  maintain operations
• Long term management of funds and pensions

• Objectives of Cash Management
  –   Ensure safety of public resources
  –   Maintain liquidity when needed
  –   Increase funds available for investment
  –   Obtain the highest feasible yield on public funds
         The Cash Budget and
          Cash Management
• Governments used to hold 40% of assets in
  cash…now it’s less than 5%

• Reasons include:
   – Better cash-management techniques, like cash
     budget forecasting and ease of transfer
   – Public demand for better returns
   – Cash management provides revenue without taxes
   – Cash coming in continually and spending is steady

• Constant battle between yield v risk v liquidity
Elements of Cash Management
• Managers bridge the gap between daily
  disbursement outflows and revenue
• Holding excess cash means lost interest
  earnings…not holding enough cash
  means you can’t pay your bills
• Cash includes
  – Currency on hand
  – Checkable deposits (demand-deposit
    accounts, NOW accounts)
Elements of Cash Management
Cash (and checking)
  – are liquid (immediately available
  – earn little or no interest
  – don’t lose value (safe)
  – have low transaction costs
• Short term investments
  – earn interest
  – are quickly marketable
  – have low transaction costs
Elements of Cash Management
• Cash management includes:
  – Controlling the cash-collection and cash-
    disbursement process
  – Managing the available cash balances
  – Investing those balances in short-term
• Strategies to speed collection and slow
  – Accelerate collection
  – Control disbursements
  – Consolidate balances
         Accelerating Collection
•   Deposit all revenue as quickly as possible
•   Prompt billing of funds owed
•   Rapid processing of remittances
•   Control of nonpayment

• Electronic Funds Transfer (EFT) is fastest
• Collection and deposit float:
    – Mail time + record keeping & processing + check
      clearing at the taxpayer’s bank
    – Lockbox systems cut float time
• Credit card payment becoming widespread
      Controlling Disbursements
• Verify claims before payment
• Avoid late payment penalties
• Balance early-payment discounts against
  interest that could be earned
• Use of zero-balance accounts (in some places)

• Disbursements fall into 4 categories
  –   DEBT SERVICE (usually paid to an institution)
  –   CAPITAL OUTLAYS ((bond proceeds)
  –   PURCHASES (supplies, equipment, contracts)
        Consolidating Balances

• Concentration Accounts
  –   Produces a large investment pool
  –   All revenues go into the cash pool
  –   Ensures longer availability of larger investment dollars
  –   Reduces the impact of bad checks
  –   Institutions offer higher interest for larger amounts
  –   Lower transaction costs (fewer transactions)
  –   Pooling is NOT co-mingling of funds…records are
        Investing Idle Funds
• Seeks to determine the minimum cash
  balance required in a government
  checking account
• Cash manager must evaluate tradeoff
  between holding too much cash and being
  short of cash
• Cash held has declined due to
  – Higher interest rates
  – Improved computer technology
  – Lower computer and transaction costs
        Investing Idle Funds
• Key elements for successful forecasting
  – Make errors on the conservative side
  – Pay most attention to the major items
  – Keep the forecast simple
  – Maintain documentation on how forecasts
• Be aware of T-bills, money markets,
  interest rates, world economic conditions
         Investing Idle Funds
• Inappropriate investments
  – Default risk…loss of principal due to failure
  – Credit market risk…loss of market value due
    to interest rates
  – No artificially low rates of return (state/local
    governments…low interest from tax-exempt
    status…no point, since already exempt)
  – No illiquid assets
• Many constraints placed on cash
        Investing Idle Funds
• Commonly employed interests
  – T-Bills…U.S. Treasury, weekly auctions, safe,
  – Other federal agency issues
    • National Mortgage Association, Federal National
      Mortgage, Federal Home Loan Bank, others
  – Negotiable Certificates of Deposits (CDs)
    • Not always fully insured, fairly safe and lquid
  – Commercial paper
    • Short term, unsecured promissory notes
    • Higher risk, lower marketability
          Investing Idle Funds
• Repurchase agreements (REPO) and reverse
  repurchase agreements
  – Investor purchases a security, seller promises to buy
    it back
  – Short maturity, rate slightly lower than the instrument
  – This market is unregulated and unsecured
• State and local debt
  – Helps shore-up localities, politically-driven
  – Usually low-yield, long-term, and risky
• State investment pools
  – Designed for government short term investment
  – Money-market mutual funds (usually not legal)_
• Money-market mutual funds
       Measuring Performance
•   Total financial assets held
•   Demand deposit and currency total
•   Interest received to date, this year
•   Interest received to date, last year
•   6-month T-bill rate, this year
•   6-month T-bill rate, same week last year
Managing Public Pension Funds
• Long term, less restrictions, large, tax-exempt
• Should meet the following criteria:
  – Creditworthy, liquid, market rate of return
• Subject to past abuses
  –   Some governments have used to finance own debt
  –   Used as a resource for public money
  –   Sometimes constrained to support local firms
  –   Must consider social/economic development
Managing Public Pension Funds

• Two types of retirement programs
  – Defined-contribution plan
    • Employer regularly contributes to an employee’s
      retirement account but makes no guarantee on
      amount of benefits
    • Payout depends on what went in
  – Defined benefit plan
    • Employer guarantees what will be paid out at
• Idle cash should be invested at highest yield
  possible consistent with safety and liquidity
• T-bills, CD’s, repos are good
• 4 steps of cash management
  – Forecasting daily cash balances
  – Pooling available funds to maximize investable
  – Investing in the most attractive instruments
  – Maintaining a scorecard for the program
• Be careful with pension funds and don’t use
  them as a cash source