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BEC III > 6. Working Capital Management > Flashcards

6. Working Capital Management Flashcards

1
Q

What is working capital?

A

Current assets - current liabilities.

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2
Q

What are current assets?

A

Cash and other resources (assets) expected to be converted to cash, sold or consumed within one year.

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3
Q

What are current liabilities?

A

Obligations due to be settled within one year.

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4
Q

What is the objective of working capital management?

A

*Maintain level of working capital so as to;
Meet on-going operating and financial needs (e.g. inventory to meet production requirements, cash to meet obligations as they come due)
*Not over invest in working capital, which provide low returns or increases cost (e.g. excess cash = a low rate of return if any. Excess A/R = no interest earning. Excess inventory = incur storage costs and risks becoming obsolete).

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5
Q

Cash management: What does “cash” include?

A

Currency, demand instruments, demand deposits.

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6
Q

Cash management: Objective?

A

To maintain a minimum balance consistent with operating needs;

  • Holding too much = loss of return to the firm
  • Holding too little = risk of not meeting debt and operating needs
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7
Q

Cash management: What is the basis for determining cash needs?

A

Cash budget.

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8
Q

Cash management: What should a firm do if projecting cash shortfall or surplus?

A
  • Shortfall: can reduce cash requirements, borrow, or make other arrangements
  • Surplus: can make investments, pay down debt or increase cash dividends
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9
Q

Cash management: What does a firm seek to do within context of a targeted cash balance?

A

Accelerate cash inflows and defer cash outflows.

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10
Q

Cash management: what does cash provide the longer a firm holds it?

A

A source of financing.

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11
Q

Cash management: What does accelerating cash inflows involve?

A

Reducing the time between when a firm has a claim to cash and when that cash is available for use.

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12
Q

Cash management: What are examples of aspects of accelerating cash inflows?

A
  • Getting the customer or other payer to initiate pmt promptly
  • Efficient handling of cash after received
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13
Q

Cash management: what is “float”?

A

The time between when pmt is initiated to a firm and when that pmt is received and available for use.

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14
Q

Cash management: What does a firm try to do re: incoming float (=availability of cash coming in)?

A

Reduce (the time between claim to cash and actual receipt)

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15
Q

Cash management: What are methods a firm uses to reduce the period of incoming float (=increasing cash inflows)?

A
  • Lock-box system
  • Pre-authorized checks
  • Concentration banking
  • Depository transfer checks
  • Wire transfers
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16
Q

Cash management: What is lock-box system?

A

Firm leases post office boxes in areas where it has high volume of cash inflow by mail.

  • Customers remits pmts to the local post office box
  • Pmts are collected processed by the firm’s bank
  • Bank notifies the firm of sources and amounts received
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17
Q

Cash management: Lock-box system: Advantages?

A
  • Cash is available sooner than it would be otherwise
  • Handling of cash reduced and security improved
  • Incident of dishonored checks is reduced and there is earlier detection of dishonored checks
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18
Q

Cash management: What is pre-authorized checks? When is this especially useful?

A

Customers authorize checks in advance for pmts of their obligations.
Useful when the amount being collected is same each period (e.g. mortgage pmt, cable bill..)

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19
Q

Cash management: Pre-authorized checks advantages?

A
  • Cash is available sooner and the amount is highly predictable
  • Firm handling of cash and collections is reduced
  • Customers may appreciate the “automatic” bill paying feature of pre-authorized checks
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20
Q

Cash management: What is concentration banking?

A

*Accelerates the flow of funds from multiple local banks to a firm’s primary bank by regular, usually automatic, transfer of funds

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21
Q

Cash management: Concentration banking advantages?

A
  • Cash available sooner to use firm-wide
  • Better control of firm-wide cash
  • Arrangements are possible for aggregated excess cash to be temporarily invested
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22
Q

Cash management: What is depository transfer checks? What is it also called?

A

Transfers funds between a firm’s accounts (also called “official bank checks”
*Check is unsigned, non-negotiable and payable only to an account of the firm
Example:
Firm makes a local bank deposit - simultaneously it writes a depository transfer check payable to the firm’s account at another bank - check moves the funds from the local bank to the alternate bank

23
Q

Cash management: Can depository transfer checks be used in conjunction with other methods?

A

Yes, with lock-box arrangements and/or with concentration banking.

24
Q

Cash management: What is wire transfers?

A

An electronic means of transferring funds.

  • Relatively expensive method of transferring funds
  • Generally provide; speed and security
25
Q

Cash management: What does deferring cash outflows involve?

A

Increasing the time between when a firm receives a resource or benefit and when cash is reduced to pay the related obligation.

26
Q

Cash management: What are methods a firm uses to increase the period of outgoing float (= keeping the cash longer)?

A
  • Management of purchase/pmt processes
  • Remote banking
  • Zero-balance accounts
  • Payment through draft
  • Positive pay system
  • Electronic funds transfers
27
Q

Cash management: What does management of purchase/pmt prices involve?

A
  • Establish and using charge accounts
  • Selecting suppliers that provide generous pmt terms
  • Pay bills only when due, except to take advantage of discounts
  • Stretch pmts by making pmts after the stated due date, but within an acceptable time customary in industry
28
Q

Cash management: What is remote banking?

A

Increases float on checks used to pay obligations by establishing checking accounts in remote locations and making pmts by checks written on those accounts.
Theoretically, checks written take longer, but practically electronic processing and banking requirements eliminated the usefulness.

29
Q

Cash management: What is zero-balance accounts by agreement?

A

BY AGREEMENT with its bank, a firm will have an account with a zero balance.
Checks are written on an account with no balance - checks are processed by the bank, resulting in an overdrawn account - Bank transfers funds from another firm account to again “zero out” account daily.

30
Q

Cash management: What is zero-balance accounts by deposit?

A

A firm deposits into an account an amount exactly equal to checks written on that account, so the account will always have a reconciled balance of zero.
Firm determines the amount paid from an account (e.g. payroll) - Deposits only the amount needed - The account has a zero-balance.

31
Q

Cash management: Zero-balance accounts advantages?

A
  • Near elimination of excess cash balances in these account

* Reduced administration (e.g. monitoring, reconciling)

32
Q

Cash management: What is payment through draft?

A

A firm uses a legal instrument - a draft (like a check) - drawn on an account of issuing bank or another bank, not the firm’s account.
Drafts are sold to customers for a fee - customers then has a check-like instrument that is guaranteed to be paid when presented.

33
Q

Cash management: What are common forms of draft?

A
  • Bank draft
  • Cashier’s check
  • Certified check
  • Money order
34
Q

Cash management: What is bank draft?

A

An order to pay drawn by a bank on itself or on a correspondent bank with which the issuing bank has an account
*Used by banks dealing with other banks
*Sold by banks to its customers for a fee
Individual basis - A single draft for a specified amount
Automatic basis - Recurring drafts for a fixed amount issued periodically and charged to a customer’s account

35
Q

Cash management: What is cashier’s check?

A

One time order today drawn on the issuing bank

  • Customer pays for the amount of check plus fee
  • Bank guarantees the check to be paid when presented
36
Q

Cash management: What is certified check?

A

Order to pay drawn on a depositor’s account that is certified to be paid by the bank

  • Bank withholds the amount of the check from the writer’s account
  • Check becomes obligation of the bank
37
Q

Cash management: What is money order?

A

Like a certified check, but sold by a non-bank institutions (e.g. post office or western union).
Usually limited in amount for each order.

38
Q

Cash management: Advantages of payment through draft?

A
  • Assures the instrument will be honored at stated value
  • May not require having a checking account or disclosure of bank account info
  • Can be automated to facilitate recurring pmts
39
Q

Cash management: Disadvantage of payment through draft?

A

Associated fee may be more costly than other forms of pmt

40
Q

Cash management: What is positive pay system?

A
  • Entity sends its bank an electronic file of checks written on its account with bank
  • Bank compares presented checks with info on the electronic file
  • If elects match, the check is paid
  • If elements do not match; issuing firm decides whether or not to approve - if not approved, the check is returned through the banking system
41
Q

Cash management: Advantages of positive pay system?

A
  • Detect unauthorized or altered checks

* Prevents inappropriate pmts from the account

42
Q

Cash management: What is electronic funds transfers?

A

Funds are transferred electronically - may be for a single transaction, but most commonly for a file of multiple transactions.
Firm transmits file electronically to its bank - Bank reduces firm’s account and forwards pmts through the Automated Clearing House (ACH) - ACH routes pmts to individual recipient accounts in various banks

43
Q

Cash management: Advantages of Electronic funds transfers?

A
  • Drastically reduced float - Pmts can be initiated at the last minutes and still be timely
  • Administration can be automated and integrated with the firm’s accounting system
  • Very low per transaction fee cost
44
Q

ST securities management: What is ST investment?

A

Investments to be held one year or less

  • Commonly used for temporary excess cash
  • Investment must be made prudently because the funds may be needed in the near term
45
Q

ST securities management: What are criteria for ST investment?

A
  • Safety of principal - little risk of default by the issuer
  • Price stability - Not subject to market declines that would result in a significant loss if sold
  • Marketability/liquidity - have a ready market for converting to cash
  • Other possible criteria - taxability, diversification, cost of administration
46
Q

ST securities management: What are major ST investment instruments? What is the market for these instruments called?

A

*US Treasury bills
*Federal agency securities
*Negotiable certificates of deposit
*Banker’s acceptances
*Commercial paper
*Repurchase agreements
Money Market

47
Q

ST securities management: What are US treasury bills?

A

Direct obligation of the US government;

  • Virtually risk free
  • Maturities of 91, 181, 365 days
  • Available periodically through the Federal Reserve Banks or continuously in the secondary market
  • Offer safety of principal, marketability, and if held to their short maturity, price stability
48
Q

ST securities management: What are Federal agency securities?

A

Issued by and obligation of the individual federal agencies (therefore, not backed by the Federal Government).

  • Ex: Federal National Mortgage Association (Fannie Mae), Federal Home Loan Bank, etc
  • Slightly higher risk than US Treasury bills and pay a slightly higher return
49
Q

ST securities management: What are negotiable certificates of deposit (CDs)?

A

Issued by a bank in return for a fixed time deposit with bank.

  • Negotiable means they can be bought and sold in the secondary market
  • High safety of principal and relative price stability
  • They are somewhat less marketable than federal securities
50
Q

ST securities management: What is Banker’s acceptance?

A

A draft (or order to pay) drawn on a bank by a firm with an account at the bank. If the bank accepts the draft, it becomes a negotiable instrument available for investment.

  • Sometimes used in financing foreign transactions
  • More risky and less marketable than federal securities
  • Pay a higher yield than federal securities
51
Q

ST securities management: What are commercial papers?

A

ST, unsecured promissory notes issued by large, established firms with high credit ratings.

  • Available in various demonizations with maturities of a few days up to 270 days
  • Less marketable than some other ST investments = pride a greater return
52
Q

ST securities management: What are Repurchase Agreements?

A

(Repos) = Securities issued for loans with a simultaneous commitment by the buyer to resell the loan security to the issuer at the original contract price plus an agreed interest for period outstanding.

  • Usually for large amounts
  • Can be for any agreed length of time
53
Q

ST securities management: Advantages of Repurchase agreements?

A
  • Can be for a short as one day

* Risk of market price declines is avoided

BEC III (10 decks)

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