Let me begin by observing that the term "float" has three different
financial meanings. Anyone who has operated a cash register is familiar
with the notion of a cash float, which is the sum of money added at the
beginning of a shift for change-making purposes and subtracted at the
end of the shift.
The cash box (or petty cash box) acts as a temporary bank
account. The float is the amount of cash placed in the box at
the start of the day. [...]
There is no formula for working out how much float you need,
but one half of the day's typical cash receipts is a good
ZDNet: Quicken tutorial: Running a Cash Box or Cash Register
Another familiar type of float is check float, which is incurred by the
delay between the cashing of a check at the payee's bank and the honoring
of the check at the payer's bank.
Float occurs when there is a delay in the clearing of payments
between banks. It is most obvious in the time delay between
when you write a check and when the funds to cover that check
are deducted from your account.
Once the holder of your check deposits it in his account, his bank
immediately credits (increases) his account, assuming that your
bank will ultimately send the funds to cover the check. Until
your bank actually sends the funds, both you and the holder of
the check have the "same" money in both of your accounts.
Once his bank notifies your bank (usually by presenting the
check you wrote and he endorsed), the "duplicate" funds are
removed from your account and the check is considered to have
"cleared" your bank.
Wikipedia: Float (money supply)
Then there is the long-term floating of funds, where an up-front payment
is used by a company to generate returns before any money is returned to
the client. This kind of float is essentially a loan made by the client
to the company. The Wikipedia article on insurance, which is the original
source of your quotation, makes explicit mention of this aspect.
Although insurers traditionally depended upon underwriting profit
to provide them with operating profit, market forces now require
that insurers earn the bulk of their profit on investment income
on premiums held pending claims occurrence. This is a form of
Wikipedia: Insurance: How an insurance company makes money
Leverage is just a recondite way of saying that money is borrowed to
support an undertaking or a transaction. In the sense of borrowing
money against future returns, the purest kind of float is found in
the bond business. In this model, a company sells bonds to investors
with the guarantee that it will buy them back for a fixed price after a
certain period has elapsed. Although bonds can be resold and revalued,
resulting in a bond market that resembles the stock market, bonds are
fundamentally different from stocks in that a bond does not represent a
stake in the issuing company, only a promise that the price of the bond
will be returned with interest in the future. Note that the action of
issuing bonds is called "floating" a bond.
If a company decides to offer, or float, bonds, the procedure
is in some ways similar to that for issuing stock. But bonds
are fundamentally different from stocks as a means of raising
capital since the investor becomes a creditor of the company,
not an owner. And the company is taking a loan, not selling
ownership. That makes the process of floating and purchasing
bonds different from issuing and buying stock in key ways.
Path to Investing: Issuing bonds
A business model that more closely resembles insurance in the way it
accrues float is the retirement fund. Here, as with insurance, regular
payments from the client are kept by the company and invested, thereby
gaining interest before eventual disbursement some years down the line.
In a defined contribution plan, contributions are paid into
an individual account for each member. The contributions are
invested, for example in the stock market, and the returns on the
investment (which may be positive or negative) are credited to
the individual's account. On retirement, the member's account is
used to provide retirement benefits, often through the purchase
of an annuity which provides a regular income.
Wikipedia: Retirement plan
Another business that collects large quantities of float is the typical
American state lottery, because the announced jackpot is paid out
in annual installments over a period of 10 years or more. The lottery
winner may opt for a single payment, but only at a significant discount
from the announced jackpot. Thus, the money collected from the sale of
tickets is a long-term float that the lottery can invest and profit from
over several years before disbursing the full amount of the jackpot.
In certain countries, such as the USA, the winner gets to choose
between an annuity payment and a one-time payment. The one-time
payment is much smaller, indeed often only half, of the advertised
lottery jackpot, even before applying any withholding tax to
which the prize may be subject. The annuity option provides
regular payments over a period that may range from 10 to 40 years.
In some online lotteries, the annual payments can be as little
as $25,000 over 40 years, with a balloon payment in the final
year. This type of installment payment is often made through
investment in government-backed securities.
Wikipedia: Lottery: Payment of prizes
In some jurisdictions, notably the UK, funeral homes accumulate large
amounts of float from funeral prepayment plans. Here, the float is
simply the amount collected at the time of prepayment and subsequently
invested so as to generate returns that will cover the inflated cost of
the funeral when the time comes. Funeral prepayment is also common in
some parts of the USA.
A funeral prepayment may be made in full or only part. Once
prepayment is made, the State of Michigan tells the funeral home
what they can do with the funeral prearrangement money. There are
two methods which include funeral insurance or a trust account.
The funeral insurance company used must be approved and regulated
by the State of Michigan. The second method, a trust account,
is set-up between the State of Michigan and the funeral home.
Your money is then put into this trust account. The professional
who helps you with your funeral prearrangement will direct you
to the form of prepayment that is best for you.
In both cases, the funeral home guarantees that you will have
the funeral you have selected and paid for. In all cases, the
money will earn interest. The interest remains in the fund and
accumulates over time. The intent is for the interest to keep
up with the cost of inflation.
The Senior Corner: Funeral Preplanning
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cash register float
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