1. PP-7-17 Hedge Market. Fits icy. Second al Resen ent Mode Problems e of the An 166. sh Conces case Butler Manufacturing Lockbox Location The Butler Manufacturing Company was corporate headquarters in Philadelphia. The started in the mid-1950s, and was a subsidiary site was adjacent to the headquarters of But- ler's largest division in terms of sales volume. of a large German firm. By 1983, annual sales had reached the half-billion dollar level. The company was organized into five divisions of unequal size. This organization resulted, in part, from the piecemeal fashion in which the company had grown through acquisitions and. in part, from attempts to parallel the parent organization's structure with respect to prod- uct lines. Each division had, until recently, been operated quite autonomously; in fact. the divisions had been separately incorpo- rated subsidiary operations until 1970. An example of how differently the five divisions were operated was provided by their respective accounts receivable management and cash application systems. The largest di- vision of the firm had annual sales of $325 million. Its cash application system was a man- ual-computer hybrid, wherein the cash appli- cation clerk identified the items being paid from alphabetical listings and manually re- moved a computer card from a deck of such cards signifying the outstanding items. The computer then compared the cards pulled against the tape record of the division's ac- counts receivable to determine which items were to be removed. The firm's second-largest division, headquartered in St. Louis (with sales of $100 million per year), used an entirely computer-based system. As checks came in, data were encoded; a computer program scanned the tape of outstanding accounts re- ceivable items to determine which had been paid. The cash application clerk audited this In 1982, the firm had decided to cen- tralize certain operations. Operating sepa- rately, each division had developed (or had inherited from its predecessor) different methods for handling various operations. Top management felt that some of these opera- tions could be better addressed on a central- ized basis. The corporate offices in New York City were closed and the company's top man- agement was moved to recently constructed This case has been adapted from Iqbal Mathur Nd Frederick C. Scherr. Cses in Financial Management and (New York: Macmillan, 1979). pp! 37-44. then cash application program by examining the check and invoice information presented on a CRT. A slightly smaller division, head- 68 Exhibit 1 Plant Locations Virginia Headquarters Location Philadelphia Butler Manufacturing Some Characteristics of Five Divisions Annual Sales Number of Checks (Millions) Received per Year $325 67,000 Texas St. Louis Missouri $100 25,000 Charlottesville Virginia $80 53,000 New Jersey Los Angeles California $40 81,000 New York None--Products $10 20,000 imported from Germany quartered in Charlottesville, Virginia (annual sales of $80 million), used a totally manual system; copies of invoices generated by this division were physically filed in alphabetical order as they were generated. When paid, they were removed from the file and stored by date of payment. The firm's smallest division, headquartered in New York (with annual sales of $10 million), used a similar system. The remaining division was headquartered in Los Angeles and had annual sales of $40 million. Its cash application and accounts receivable system was similar to that of the Philadelphia division except that no manual cards were used. The cash application clerk worked from com- puter printouts; after he had determined what item had been paid, this data was encoded and the paid item removed from the accounts receivable data tape. A chart of the divisions and some of their characteristics is presented in Exhibit 1. and disbursing bank account for cash receipts and trade payments. Each division also had a payroll account at a local bank for each plant and/or headquarters location. Money was wire transferred into these payroll accounts on the day that paychecks were written, and drawn out by employees shortly thereafter. Sales of fices (which were scattered about the United States) were not allowed to have local bank accounts; emergency needs were met from petty cash. Other disbursements were made from the divisional receipts and disburse: ments accounts. Paychecks for field salesmen were mailed to their homes, and were drawn on payroll accounts at their division's head- quarters locations. The corporate headquar ters used the accounts of the Philadelphia di- vision. It was the company's policy to pay for all bank services on a straight fee (rather than compensating balance) basis. with Like the divisions' cash application and ments and the payroll accounts, the Philadel In addition to the receipts and disburse accounts receivable systems, their cash man- phia division had several small accounts agement policies also differed substantially, international banks. This division did a siz though top management had recently made able export business, and it was felt that some attempts at coordination and rationali- having these accounts was necessary to facili zation. Each division kept a central receiving tate receipts from export sales. A chart of C Buder Manufacturing Lockbox Location Exhibit 4 Butler Manufacturing Company Average Mail Times between Parts of the Country in Days Destination Northeast Southeast N. Central S. Central Northwest Southwest Origin Northeast 2.2 2.3 2.8 Southeast 2.3 2.1 3.2 2.9 30 3.0 3:5 4.2 4.2 3.6 North Central 2.8 3.2 2.5 3.0 2.9 3.0 South Central 3.0 2.9 3.0 2.3 3.1 3.2 Northwest 3.5 4.2 2.9 3.1 2.5 2.6 Southwest 4.2 3.6 3.0 3.2 2.6 2.5 Exhibit 5 Butler Manufacturing Company Analysis of Customer Pay-from Location by Division (percent of total receipts) Division *>Philcdelphia St. Louis Charlottesville Los Angeles New York Northeast 31 42 30 0 76 Southeast 21 32 61 0 20 North Central 20 2 0 0 0 South Central 9 27 0 Northwest 2 10 0 26 0 + Southwest 17 17 0 74 4 71 er ing would be required with respect to this bid. received from outside a region. Butler's re- For the other location proposals, daily wire quired rate of return on any funds freed due transfers of collections would add $6,000 per to decreased float was 8 percent. Remittance year to the lockbox costs. Average mail times, origin locations (pay-from locations) for But- between regions are given in Exhibit 4. But: ler's customers are given in Exhibit 5. ler's management decided to add one day to these mail times to account for clearing and 'This structure of clearing times is assumed for Within a region and 1.5 days for all checks and thus from lockbox location to lockbox location. Processing float for all checks received from simplicity. Clearing times usually vary from bank to bank. Butler Manufacturing Lockbox Locati 70 funds. For example, the Philadelphia division did substantial business with customers in Vir- ginia and in the Carolinas. However, under the current system all the checks from these customers were sent to the division's lockbox in Philadelphia even though the firm had a much closer lockbox in Charlottesville serving the division based there. To address these problems, the firm's treasurer decided to rationalize the firm's cash collection system. The divisions would no longer operate their own collections systems. Instead, a series of lockboxes would be set up across the country; a customer of any division would be instructed to send remittances to the lockbox that would result in the shortest flo- tation. Concentration bank accounts would be set up at the firm's Philadelphia bank, and the receipts to these lockboxes would be trans- ferred to the concentration account at the end of each day. Needed funds would be trans- ferred to the disbursement accounts at the di- visions as needed, similar to the procedure currently used for payroll disbursements at plant' locations. It was felt that this concen- tration system would eliminate the transfers between divisions and result in the minimum economical flotations on incoming funds. The main question was where to put the lock- Exhibit 3 Butler Manufacturing Details of Lockbox Bids Processing Yearly Lockbox Cost per Fixed Location Check Fee Northeast $0.145 $2.500 Southeast $0.130 $2.000 North Central $0.160. $1.500 South Central $0.140 $2.500 Northwest Southwest $0.175 $4,000 $0.180 $3.500 acceptable for the firm. These levels related to how much time and attention the bank pro- viding the lockbox service would give to each check, how much information would be for- warded to Butler regarding each check, and how this information would be forwarded. The most expensive service involved the manual handling of each check, and the forwarding of the envelope in which the check was re- ceived, any remittance advice on how the check was to be applied, and a photocopy of the check itself. This careful handling and com- plete forwarding gave Butler the most infor mation about each received check but was rel- atively costly (about $0.25 per check). The To address this problem, the firm di- data about each check (usually a computer least expensive service provided only minimal vided the originating zip codes of incoming printout listing only the payer and the check checks into six regions and solicited bids from amount), and generally cost about $0.11 per one bank in each of these regions that could check. Butler decided that an intermediate provide lockbox services. The details of these level of information (and thus processing boxes. bids are presented in Exhibit 3. Prior to soliciting these bids, Butler had to decide what level of lockbox service was *The situation here has been considerably simpli- items paid by each check received, and had specified this level of service in soliciting lock charges) would be sufficient to identify the box bids from each of the banks. A few more details on these bids are fied to aid in calculation. Typically, two-digit zip code useful. The bid from the bank in the Northeast designations are used to designate regions (resulting in 100 regions) and many more offers are solicited, including region was from the concentration bank in some from several banks in the same region. Philadelphia. Thus, no daily wire transfers ipts da ant wire Butler Manufacturing Lockbox Location Exhibit 2 Butler Manufacturing Current Location and Number of Bank Accounts Rec.-Disb. Payroll International Total Headquarters Account Account Account Account Location Locations Locations Locations Locations Philadelphia Philadelphia Virginia New York 9 Texas (5) Pennsylvania St. Louis St. Louis Missouri None 2 Charlottesville Char. Virginia None 3 New Jersey Los Angeles Los California None 2 Angeles New York New York None- None 1. Products Imported from Germany 69 se men WO ad- the WO of ted Exhibit 2. 17 =1 the bank accounts of the firm is presented in quarters then combined these forecasts and planned the firm's borrowing and investment To facilitate the deposit of checks, most strategies. However, with five divisions and ank of the divisions kept lockboxes at the bank thus five receipts and disbursements accounts, om handling their receipts and disbursements ac- coordination was a problem. After the cash ade count. The exception was the Los Angeles managers at headquarters had stripped off ex- division. The credit manager of this division cess cash, unexpectedly low receipts at any was opposed to using a lockbox because he division could cause a cash stockout at that felt that too large a portion of the checks for division's disbursements account. This was his division were nonroutine items: they were handled by transferring cash from the ac- destrictively endorsed," postdated, and so on. counts of one or more other divisions that had Lockboxes do not handle these items well. It experienced greater-than-expected receipts. had not been determined if this contention. This transfer procedure led to substantial ad- valid, but the Los Angeles division did ditional transfer costs and had necessitated deal (on average) with smaller customers than significant time and effort on the part of the se el ith iz li of ar- di- for an was the other divisions, corporate cash management group to make Centralization of Butler's cash manage- and record such transactions. changes. The division had been required to trary location of the firm's lockboxes needed submit weekly and monthly cash forecasts to be reconsidered. It was obvious that the showing expected future bank balances. The divisionalized character of the lockbox loca- cash management staff at the corporate head- tions did not lead to the quickest receipt of