What is Financial Float?
In financial terms, the float is money within the banking system that is briefly counted twice due to time gaps in registering a deposit or withdrawal. These time gaps usually occur due to the delay in processing paper checks. A bank credits a customer’s account as soon as a check is deposited. However, it takes time to receive the check from the payer’s bank and record it. Until the check clears the account it is drawn on, the amount it is written for “exists” in two different places, appearing in the accounts of both the recipient’s and payer’s banks.
Key Benefits and Risks of Float
- Double-Counting: The float is essentially double-counted money: a paid sum which, due to delays in processing, appears simultaneously in the accounts of the payer and the payee.
- Financial Leverage: Both individuals and companies can use float to their advantage, gaining time or earning interest before payment clears their bank.
- Legal and Fraud Risks: Playing with float can venture into wire fraud or mail fraud if it involves the use of others’ funds.
Diving Deeper: Understanding the Float
The Federal Reserve defines two types of float:
- Holdover Float: Results from delays at the processing institution, typically due to weekends and seasonal backlogs.
- Transportation Float: Occurs due to inclement weather and air traffic delays and is, therefore, highest in winter months.
The Fed, which processes one-third of all checks in the United States, notes that although the amount of float fluctuates randomly, there are definite weekly and seasonal trends. For instance, float usually increases on a Tuesday due to a backlog of checks over the weekend and during December and January because of higher check volume during the holiday season.
The Federal Reserve uses these trends to forecast float levels, integrating them into the actual day-to-day implementation of monetary policy.
Mastering the Calculations Involved in Float
The formula to calculate float is straightforward: Float = Firm’s available balance - Firm’s book balance
The float represents the net effect of checks in the clearing process. A common measure of float is the average daily float, calculated by dividing the total value of checks in the collection process during a specified period by the number of days in the period. The total value of checks in the collection process is derived by multiplying the amount of float by the number of days it is outstanding.
Example Calculation
For a company with $15,000 of float outstanding for the first 14 days of the month and $19,000 for the last 17 days, here’s how to calculate the average daily float:
[($15,000 x 14) + ($19,000 x 17)] ÷ 31
= ($210,000 + $323,000) ÷ 31
= $533,000 ÷ 31
= $17,193.55
Strategic Uses of Float
Individuals often use float to their advantage. For example, Amanda has a credit card payment for $500 due April 1. On March 23, she writes and mails a check for that amount, knowing she doesn’t have $500 in her account yet. However, her paycheck of $1000 will be deposited by March 25. She counts on the fact that the credit card company will not present the check for payment until April 1, thus using the float for those days.
In a tech-savvy move, Amanda could do similar by scheduling an electronic payment on the credit card company’s website for April 1, counting on her paycheck clearing the bank in time.
The Future of Float: Transitional Trends
Technological advances have spurred measures substantially speeding up payment processing, thereby reducing float. Innovations such as electronic payments, funds transfers, direct deposit of paychecks, and electronic check presentation have reduced the significance of float.
As a result, float in the United States has seen a dramatic decline—from a record daily average of $6.6 billion in the late 1970s to only $774 million in 2000, as recorded by the Federal Reserve.
The steady reduction in check usage combined with rapid adoption of payment innovations may render float a relic of the past.
Real-World Example: Advantages and Caution
Large companies and financial institutions often engage in playing the float with significant sums—earning interest income by either speeding up deposit into their accounts or delaying presentation for payment. Such actions, while legal under certain parameters, risk crossing into territory defined as wire or mail fraud when involving others’ funds.
Case Study: E.F. Hutton & Company Scandal
In 1985, E.F. Hutton & Company pleaded guilty to 2,000 charges for systematically overdrawing accounts to fund others, writing checks on funds they didn’t have to profit from the float. This grand-scale floating scheme concocted sizable, unauthorized loans from banks, epitomizing the risky realms of playing the float.
On a larger economic scale, float, being double-counted money, can distort measurement of a nation’s money supply by inflating the amount briefly present in the banking system.
Related Terms: deposit, withdrawal, Federal Reserve, holdover float, transportation float, monetary policy.
References
- Federal Reserve Bank of New York. “Float”.
