2.5 MANAGING THE FIRM’S INVESTMENT IN CURRENT ASSETS Flashcards
What are the primary types of current assets that most firms hold?
Cash and marketable securities, accounts receivable, and inventories
What tool is primarily used to maintain an adequate amount of cash?
The firm’s cash budget, which helps forecast cash receipts and disbursements.
What is the tradeoff of holding too little cash?
It could lead to potential default on the firm’s financial obligations.
What is the first fundamental problem of cash management?
Keeping enough cash on hand to meet the firm’s cash disbursal requirements on a timely basis.
What are money market securities?
Investments with maturities of less than one year, virtually no default risk, and can be easily bought and sold.
What is the cost of holding excessive amounts of cash and marketable securities?
They earn very low rates of return, which can be costly for the firm.
What is the second fundamental problem of cash management?
Managing the composition of the firm’s marketable securities portfolio.
How does a sale on credit affect a firm’s accounts receivable?
It increases the accounts receivable balance, delaying cash flow until the account is collected.
Why is controlling receivables important for a firm?
Efficient collection policies and procedures improve both profitability and liquidity.
What do credit terms indicate?
They identify possible discounts for early payment, the discount period, and the total credit period, often stated as “a/b, net c.”
What factors can be analyzed to determine customer quality?
Liquidity ratios, other obligations, and overall profitability of the customer.
What factors determine the size of the investment in accounts receivable?
The level of credit sales as a percentage of total sales, the level of sales, and the credit and collection policy.
How does declining customer quality affect a firm?
It increases the costs of credit investigation, default, and collection.
What role do credit rating services play?
They provide information on the financial status, operations, and payment history of firms.
How does the age of an account affect the probability of default?
The probability of default increases with the age of the account.
