3B Flashcards
The amount of inventory that a company would tend to hold in stock would increase as the:
sales level falls to a permanently lower level.
cost of carrying inventory decreases.
cost of running out of stock decreases.
length of time that goods are in transit decreases.
cost of carrying inventory decreases.
The ____is the least amount of inventory that should be ordered given the various costs involved. The ____model (EOQ) provides a formula for determining the quantity of a particular inventory item that should be ordered in order to minimize inventory costs.
EOQ = Square root of (2DS/Ci)
D = The demand per year in units
S = Setup or ordering cost per order or batch
C = The cost per unit
i = The carrying costs expressed as a percentage
economic order quantity
RATIOS/FORMULA
Cost of Goods Sold
Inventory Turnover
Number of Days Sales in Inventory
Safety stock
Daily Usage
ROI
Return on Assetst
Reorder Point
COGS= Sales - Gross Profit
Inventory Turnover = Cost of Goods Sold / Average Inventory
Number of Days Sales in Inventory = 360 / Inventory Turnover
Safety Maximum Usual Daily
stock = (lead time - lead time) x usage
DDaily usage = Total units / time period
ROI: Net income / Invested CAP
ROA: Net Income / Avg Total Assets
Reorder = usage per day x lead time
Reasons for not minimizing inventory levels
- ___ = guarantee availability of inventory as needed
- __- = customers can be convinced to purchase larger quantities
- If ___is very high, suppliers may feel the need to increase inventory levels to insure prompt deliveries to customers.
- Inventories can be a good hedge against inflation if the ___
- ___is a level of inventory that is held in excess of the desired inventory level to cover unanticipated demand.
Larger inventory Discounts/favorable credit terms competition cost of replacing inventory is increasing. Safety stock
The ___ratio measures the speed with which inventory can be converted into sales. I
WHATS THE RATIO?
___increase as the size of the order increases. _____ costs, however, decrease as the size of the production run or order increases.
inventory turnover
Avg Inventory
CarryingCost. Set-up or ordering
Reasons a low turnover can happen
- ___ items
- Unanticipated ___ demand
- Build-up to meet expected future demand T/F
- Build up to avoid price increases / inflation T/F
- Build up , anticipating a strike or shortage T/F
Obsolete
Weak
DAYS SALES IN INVENTORY
This measures the number of months it takes to sell the inventory.
What is the ratio?
IS a high or a low ratio preferred?
This is NOT a good indicator of how long it takes a company to turn inventory into cash.
False - number of days
Ratio = 360 / Inventory turnover
Low ratio is preferred
Falses -yes it is
Selected financial statement data for company Aye is shown as follows:
Additional paid-in capital $ 20,000
Accounts payable (current) 40,000
Accounts receivable (net) 100,000
Cash and marketable securities 70,000
Common stock 150,000
Notes payable (long-term) 50,000
Property, plant, and equipment (net) 150,000
Retained earnings 60,000
What is Aye’s net working capital?
$130k
Net working capital is current assets minus current liabilities.
Aye’s net working
capital = Current assets - Current liabilities
= Cash + Accounts receivable - Accounts payable
= $70,000 + $100,000 - $40,000
= $130,000
Current assets − Current liabilities = ???
Current assets − Current liabilities = Net working capital
A firm’s dividend policy may treat dividends either as the residual part of a financing decision or as an active policy strategy.
Treating dividends as the residual part of a financing decision assumes that:
earnings should be retained and reinvested as long as profitable projects are available.
dividends are important to shareholders, and any earnings left over after paying dividends should be invested in high-return assets.
dividends are relevant to a financing decision.
dividends are costly, and the firm should retain earnings and issue stock dividends.
earnings should be retained and reinvested as long as profitable projects are available.
OVERVIEW
The sources of financing for an organization can be found on the right side of the balance sheet—debt and \_\_
debt and equity.
The _____ theory indicates that the order of financing of a company (or project) follows the path of least effort.
- Companies use ____ financing first
- ____ will be adapted to financing needs
3/ If outside financing is required, a company will start w/ the ___ secuirty first
Internal
Dividend Policy
Cheapest
Spotech Co.’s budgeted sales and budgeted cost of sales for the coming year are $212,000,000 and $132,500,000, respectively. Short-term interest rates are expected to average 5%. If Spotech could increase inventory turnover from its current eight times per year to 10 times per year, its expected cost savings in the current year would be:
$165,625
The key to this problem is to determine how much inventory is reduced by the increased inventory turnover and the resulting savings in interest costs due to reduced working capital requirements.
The formula for inventory turns is annual cost of sales divided by inventory. Solve for inventory by dividing annual cost of sales by inventory turns.
Initially, Spotech has an inventory level of $16,562,500 ($132,500,000 divided by 8 turns). Spotech hopes to decrease the level to $13,250,000 by increasing inventory turns to 10 ($132,500,000 divided by 10 turns)
. Working capital is reduced by this change in inventory ($16,562,500 - $13,250,000 = $3,312,500). The interest avoided on the $3,312,500 represents a savings of $165,625 ($3,312,500 × 5%).
Which of the following effects would a lockbox most likely provide for receivables management?
Minimized collection float
Maximized collection float
Minimized disbursement float
Maximized disbursement float
Min collection float
Without the use of a lockbox, the payer writes and mails the payment. The payee receives the check that is processed in-house for one to two days before being deposited in the payee’s bank. It will generally take two days for the funds to clear the Federal Reserve System before those funds are available in the payee’s bank account.
A lockbox system allows the payment to go directly from the payer to the bank, thus eliminating the in-house processing at the payee’s office. In such a scenario, the collection float is reduced by one to two days.
A____is a system where checks are sent to post office boxes rather than corporate headquarters. Funds are collected y the bank.
A \_\_\_\_ can significantly reduce the time required to receive funds and make them available for use T/F
lockbox
The following information was taken from the income statement of Hadley Co.:
Beginning inventory $17,000
Purchases 56,000
Ending inventory 13,000
What is Hadley Co.’s inventory turnover?
Cost of goods sold equals beginning inventory of $17,000 plus purchases of $56,000, less ending inventory of $13,000, for cost of goods sold of $60,000.
Average inventory is beginning inventory of $17,000 plus ending inventory of $13,000 divided by 2, or $15,000.
Inventory turnover is cost of goods sold ($60,000) divided by average inventory ($15,000), or 4.0.
All of the following about the economic order quantity (EOQ) model are true, except:
the EOQ model is designed to determine an optimal order size that will minimize inventory costs.
the use of a just-in-time inventory system makes the EOQ model irrelevant.
the values in the EOQ model cannot remain constant for any material length of time during a period of inflation.
the reorder quantity determined using the EOQ model is best for companies requiring flexibility.
the reorder quantity determined using the EOQ model is best for companies requiring flexibility.
The EOQ model determines a particular reorder quantity. However, some companies require a great deal of flexibility in taking advantage of an opportunity to stockpile inventory before a price increase or as a protection against shortages.
Although the EOQ model provides valuable information in regard to the optimal reorder quantity, it does not give management flexibility.
Since the just-in-time inventory system does not require inventory, this inventory system makes the EOQ model irrelevant.
The gross margin ratio can be subjected to detailed analysis by a firm’s:
creditors.
customers.
investors.
management.
management.
Sales = Unit Price x Number of Units
COGS = Unit Cost x Number of Units
GM= (Unit Price - Unit Cost) x Number of Units
The above detailed information is available only to the firm’s management.
Thus, a detailed analysis could not be performed by the other parties mentioned.
The ___ratio compares the gross profit generated by the net sales revenue
WHATS THE RATIO
This ratio is generally more useful to management than to creditors or investors since the data necessary to analyze why changes occurred in the ratio are only available internally. T/F
gross margin
Gross margin Gross margin in ratio = -----------------
Net sales revenue
True
Each of the following periods is included when computing a firm’s target cash conversion cycle, except the:
inventory conversion period.
payables deferral period.
average collection period.
cash discount period.
Cash Discount Period
The cash conversion cycle is the amount of time it takes between investing cash in inventory and eventual recovery of cash due to the sale of the inventory. C
The ___cycle is the amount of time it takes between investing cash in inventory and eventual recovery of cash due to the sale of the inventory.
It represents the amount of time that funds are tied up in ____
cash conversion
non-cash current assets.
OVERVIEW - PERIODS
The ___period is the average time that inventory is held in days before being sold.
The \_\_\_\_period is the average time that receivables are outstanding before they are turned into cash.
The ____period is the average time that short-term obligations related to the purchase/production of inventory are outstanding.
inventory conversion
receivables collection
payables deferral
Which of the following responses is not an advantage to a corporation that uses the commercial paper market for short-term financing?
This market provides more funds at lower rates than other methods provide.
The borrower avoids the expense of maintaining a compensating balance with a commercial bank.
There are no restrictions as to the type of corporation that can enter into this market.
This market provides a broad distribution for borrowing.
There are no restrictions as to the type of corporation that can enter into this market
_____is short-term, unsecured notes that are offered by stable companies
The advantages of commercial paper include:
- Additional source of funds
- Higher rates than traditional bank loan
- Absence of costly financing arrangements & compensating balance
- If repeatedly issued, it improves borrower’s reputation in the financial markets
The primary disadvantage of commercial paper is that if a firm is facing temporary financial difficulties, it would not be able to utilize this source of funding. T/F
Commercial paper
T
F - Lower Rates
T
T
True
Morton Company needs to pay a supplier’s invoice of $50,000 and wants to take a cash discount of 2/10, net 40. The firm can borrow the money for 30 days at 12% per annum plus a 10% compensating balance.
Assuming Morton Company borrows the money on the last day of the discount period and repays it 30 days later, the effective interest rate on the loan is:
13.33%
The invoice total less the cash discount ($50,000 - 2%) is $49,000.
Morton Co. must borrow $54,444 ($49,000 plus compensating balance of 10% of loan). To calculate: $49,000 represents 90% of the loan. $49,000 ÷ .9 = $54,444.
Interest at 12% per annum on this amount for 30 days, totals:
0.12 × (30 ÷ 360) × $54,444 = $544.44
The effective yield is then (annualized):
$544.44 ÷ $49,000 × 12 months = 0.1333, or 13.33%
Which of the following cash management techniques focuses on cash disbursements?
Lockbox system
Zero-balance account
Preauthorized checks
Depository transfer checks
Zero-balance account
A zero balance account (imprest fund) is a checking account that normally carries a zero balance.
As the checks clear, the balance in the account equals the outstanding checks, and when all have cleared, the balance in the account is again zero. It is a common control on cash disbursements.
A lockbox system is used with cash deposits, not cash disbursements
____accounts are held at zero until a claim is made against the account. At that time, the holding bank transfers sufficient funds from an interest-bearing account to the zero balance account. The firm must have at least one additional account with the bank, and there is generally a small fee associated with transfers.
A zero balance account can be effectively used by an organization when the interest earned in the interest-bearing account is greater than the fees associated with the transfers of funds. T/F
Zero balance
True
Edwards Manufacturing Corporation uses the standard economic order quantity (EOQ) model. If the EOQ for Product A is 200 units and Edwards maintains a 50-unit safety stock for the item, what is the average inventory of Product A?
150
The average inventory level when the standard economic order quantity model is used is one-half of the EOQ.
The EOQ for Product A is 200 units. One-half of 200 is 100.
Add the 50-unit safety stock to arrive at 150 units as the average inventory of Product A.
A company uses the following formula in determining its optimal level of cash:
C* = Square root of 2bT/i
Where:
b = Fixed cost per transaction i = Interest rate on marketable securities T = Total demand for cash over a period of time
This formula is a modification of the economic order quantity (EOQ) formula used for inventory management. Assume that the fixed cost of selling marketable securities is $10 per transaction, and the interest rate on marketable securities is 6% per year. The company estimates that it will make cash payments of $12,000 over a 1-month period. What is the average cash balance (rounded to the nearest dollar)?
This is the square root of 2 times the fixed cost ($10) times the total demand in one month ($12,000) divided by the interest rate for one month (.06 divided by 12). Of course you need to use the interest rate for one month, not one year, because the applicable period of time is one month
The average cash balance will be one-half of the optimal level of cash because the balance will be used down to zero and will be replenished to the optimal level. The average of zero and $6,928 is the sum (0 + $6928) divided by 2, or $3,464.
FOUR REASONS TO HOLD CASH
- ____purposes - day to day biz
- ___purpose - unanticipated fluctuations
- ____Purpose - take advantage of biz opps
- Meet ____balance requirements
___cash flows matches the cash outflows with the timing of the receipt of cash inflows.
Transaction
Precaution
Speculative
Compensating balances
Synchronizing
If a retailer’s terms of trade are 3/10, net 45 with a particular supplier, what is the cost on an annual basis of not taking the discount? Assume a 360-day year.
31.81%
Terms of trade credit of 3/10, net 45 means a 3% discount may be taken if the bill is paid in 10 days or the full amount must be paid in 45 days.
the actual interest rate for the period is derived by calculating .03 ÷ .97 or 3.093%.
This interest rate is charged over a time period of 35 days (45 days minus 10 days).
There are 10.286 35-day periods in 360 (360 ÷ 35).
Therefore, the cost of not taking the discount on an annual basis is 10.286 × 3.093% or 31.81%.
To determine the inventory reorder point, calculations normally include the:
ordering cost.
carrying cost.
average daily usage.
economic order quantity.
average daily usage.
The reorder point (RP) is the inventory level at which an order is placed. The reorder point is average demand during the lead-time period plus any safety stock.
A company purchases inventory on terms of net 30 days and resells to its customers on terms of net 15 days. The inventory conversion period averages 60 days. What is the company’s cash conversion cycle?
The cash conversion cycle is the time between the investment of cash in inventory and the return of cash after the sale and collection of the related account receivable
. In this case, cash is not invested in the inventory until 30 days into the 60-day inventory conversion cycle.
The remaining 30 days of the inventory conversion cycle plus the 15-day receivable collection period results in a 45-day cash conversion cycle.
The Dixon Corporation has an outstanding 1-year bank loan of $300,000 at a stated interest rate of 8%. In addition, Dixon is required to maintain a 20% compensating balance in its checking account. Assuming the company would normally maintain a zero balance in its checking account, the effective interest rate on the loan is:
10%
The $300,000 loan is going to cost Dixon Corporation $24,000 (8% times $300,000).
However, if the bank is going to require a 20% compensating balance, then Dixon Corporation will only have an effective use of $240,000 ($300,000 - ($20% × $300,000)).
The $24,000 interest charge then becomes interest on $240,000, (the amount that Dixon is allowed to use of the $300,000 loan).
$24,000 ÷ $240,000 represents an effective interest rate of 10%.
Financial information about a company is as follows:
Receivables $ 4,000,000
Inventory 2,600,000
Payables 3,700,000
Sales 50,000,000
Cost of goods sold 45,000,000
Assuming a 365-day year, what is the number of days in the company’s cash conversion cycle?
20.3 days
DIO = $2,600,000 ÷ ($45,000,000 ÷ 365) = 21.09 DSO = $4,000,000 ÷ ($50,000,000 ÷ 365) = +29.20 DPO = $3,700,000 ÷ ($45,000,000 ÷ 365) = -30.01 CCC = 20.28, or 20.3 rounded
___is the difference between the company’s checkbook balance and the bank’s balance.
It represents the __effect of checks in the process of collection.
Checks written by the firm create disbursement float and reduce the ___.
Checks received and deposited by the firm create collection float and increase the __.
As checks are cleared, the bank cash position is reconciled to the __cash position.
Float
net
book cash
book balance
book
____ are official bank checks that provide a means of moving funds from one account to another within the banking system
Depository transfer checks (DTCs)
Assumptions of economic order quantity analysis include the following:
____for the good is known.
Total carrying costs vary with ___ordered.
Costs of placing an order are unaffected by ___.
Purchase costs per unit are not affected by __
Periodic demand
quantity
quantity ordered
quantity discounts.
Which of the following ratios is appropriate for the evaluation of accounts receivable?
Days sales outstanding
Return on total assets
Collection to debt ratio
Current ratio
Days sales outstanding
The collection to debt ratio is incorrect because the question asks about receivables, not debt.
The ___ is a sterner test for liquidity than the current ratio due to the fact that it includes only the more liquid of the current assets in the calculation.
RATIO?
quick ratio (acid-test ratio)
Quck = Current Assets - Inventory
——————————————-
Current Liabilities
The ____ratio measures both the quality and liquidity of the accounts receivable.
RATIO?
The accounts receivable turnover ratio measures both the quality and liquidity of the accounts receivable.
Net credit sales A/R turnover = --- ------------------------
Average accounts receivabl
A company has daily cash receipts of $150,000. The treasurer of the company has investigated a lockbox service whereby the bank that offers this service will reduce the company’s collection time by four days at a monthly fee of $2,500. If money market rates average 4% during the year, the additional annual income (loss) from using the lockbox service would be:
-$6K
In this question, the daily cash receipts of $150,000 can earn interest for four days at the annual rate of 4%:
Interest = Principal x Rate x Time
= $150,000/day x .04/year x 4 days
= $24,000
The cost to the company is the monthly bank fee of $2,500. Net annual loss is:
$24,000 - ($2,500 × 12) = $24,000 - $30,000 = $(6,000)
Morton Company needs to pay a supplier’s invoice of $50,000 and wants to take a cash discount of 2/10, net 40. The firm can borrow the money for 30 days at 12% per annum plus a 10% compensating balance.
The amount Morton Company must borrow to pay the supplier within the discount period and cover the compensating balance is:
$50,000(1.00 - 0.02) + 0.10(Loan) = Loan
$49,000 + 0.10X = X
$49,000 = X - 0.10X
$49,000 = 0.90X
$54,444 = X
Basically, you need to borrow $49k. The $49k is the invoice less the cash discount. Since you want to take the discount, you’ll need to borrow the invoice less the discount.
You need a 10% compensating balance. You need to borrow $49k, so the $49k is only 90% of the loan you’ll need and the 10% is the remaining amount.
$49k / .90 = $54,444.
