B3-FINANCIAL MANAGEMENT-Working Capital Management

Question 1

Net Working Capital

Answer 1

Current Assets - Current Liabilities

Question 2

Aggressive Working Capital Management

Answer 2

Increase the ratio of current liabilities to noncurrent liabilities (more current assets financed with current liabilities).

i.e. less working capital, and lower current ratio and thus assuming more risk.

Question 3

Conservative Working Capital Management

Answer 3

Increase the ratio of current assets to non current assets (more current assets financed by non current liabilities).

i.e. higher working capital, high current ratio. Assuming less risk.

Question 4

Current Ratio

Answer 4

Way of measuring short term solvency.

Current Ratio= Current Assets / Current Liabilities.

A higher current ratio is better in terms of risk reduction. Generally considered the best single indicator of a company’s ability to meet short term obligations.

Question 5

Deteriorating Current Ratio

Answer 5

Current Ratio going down, working capital going down, risk increasing

Question 6

Improving Current Ratio

Answer 6

Current Ratio going up, working capital going up, and risk is going down.

Question 7

Quick (Acid Test) Ratio

Answer 7

Cash+Marketable Securities+Receivables/ Current Liabilities

More rigorous test of liquidity than the current ratio b/c inventory and prepaids are excluded from current assets.

Question 8

Primary Methods of Increasing Cash Levels (reducing the operating cycle)

Answer 8

1. Better customer screening and credit policy-chose to extend credit to more responsible customers, who are more likely to pay bills promptly.
2. Prompt Billing-timely billing serves to speed collections 3. Payment Discounts*(heavily tested) “When you give to a customer that is a cost” “When you receive from vendor & do not take advantage this is an opportunity cost” Offering payment discounts may influence customers to pay faster and can result in improved cash collections. Discounts forgone represent higher cost to the customer than a bank loan for similar financing.
   * Formula APR of quick payment discount=*
   * 360/pay period-discount period X discount/100-discount %*
3. Expedite Deposits a. Electronic Funds Transfer-ensure timely payment. Electronic movement of funds from one institution to another. b. Lockbox Systems (good if additional interest income> than bank fees) -expedite cash flows by having a bank receive payments from a company’s customers directly via mailboxes to which the bank has access. Payments that arrive in these mailboxes are deposited into the company’s account immediately.

Question 9

Methods to Delay Disbursements

Answer 9

1. Defer Payments
2. Drafts
3. Line of Credit
4. Zero-Balance Accounts-helps to slow cash disbursements because a disbursement is made only when there is a demand.

Question 10

Cash Conversion Cycle (net operating cycle)

Answer 10

Length of time from the date of the initial expenditure for production to the date cash is collected from customers and the vendors are paid for the initial expenditures.

Formula {Inventory conversion period (# days to sell) +

receivables collection period (# days to collect)}-these two together give subtotal that is operating cycle.

When we subtract number of days to pay this give us net operating cycle. Great way to increase liquidity.

Question 11

Elements of Cash Conversion Cycle -Inventory Conversion Period

Answer 11

Inventory Turnover-COGS/Average Inventory.

Higher the turnover the better.

Inventory conversion period= 365/Inventory Turnover

Question 12

Elements of Cash Conversion Cycle-Receivable Collection Period

Answer 12

Account Receivable Turnover= Sales/Avg Accounts Receivable

Receivables Collection Period= Days Sales Outstanding (DS0)= 365/ AR Turnover

Question 13

Elements of Cash Conversion Cycle-Payables Deferral Period

Answer 13

AP Turnover= COGS/Avg AP

AP Deferral Period= 365/AP Turnover

Question 14

Cash Conversion Cycle

Answer 14

Sell quick-inventory conversion period

Collect quick-Receivables Collection Period

Slow days to pay-increase days to pay payables all this will give you a lower net operating cycle

Question 15

Management of Inventory

Answer 15

Too little-lost sales-cost Too much-carrying costs increase profits decrease

Question 16

Optimal Levels of Inventory

Answer 16

1. Inventory Turnover
2. Safety Stock
3. Reorder Point
4. Economic order quantity
5. Materials requirements planning

Question 17

Safety Stock

Answer 17

ensure that manufacturing or customer supply requirements are met. determination depends on following:

1. reliability of sales forecasts
2. cost of running out of inventory
3. lead time (time that elapse from the placement to the receipt of order)

In Inventory mgmt, the safety stock will tend to increase if the variability of lead-time increases. If lead times became more variable, the amount of safety stock needed to reduce the risk of stock outs will increase.

Question 18

Reorder Point

Answer 18

inventory level at which a company should order or manufacture additional inventory to meet demand and avert incurring stockout costs.

Reorder point= safety stock + (lead time X sales during lead time)

*lead time can be days or weeks if lead time is days tell me avg units sold per day/if lead time is in weeks than avg unit sold per week

Question 19

Economic Order Quantity

Answer 19

When I say two, you say “SOC” Minimizes both ordering and carrying costs. Assumes demand is known and is constant throughout the year.

E=Square Root(2SO/C)

E=Order size

S=Annual sales (units)

O=Cost per purchase order(primarily production set up costs) C=Carrying cost per unit

Question 20

Just in Time inventory Model (Pull approach)

Answer 20

reduce lag time between inventory arrival and inventory use. JIT reduces the need of manufactures to carry large inventories, but requires considerable degree of coordination between manufacturer and supplier.

Question 21

Marketable Securities

Answer 21

Provide much lower returns than operating assets but higher returns than cash

Question 22

Common Marketable Securities

Answer 22

1. US Treasury Bills-proxy for risk free rate-least risk
2. Negotiable Certificates of Deposit
3. Banker’s Acceptances-short term IOUs of large creditworthy corporations that are guaranteed by commercial banks
4. Commercial paper-short term lending of idle cash-notes and drafts
5. Equity Securities of Public Companies-risky b/c of the volatility of the stock market. Gains far greater than yields from other marketable securities, but losses are also more likely.
6. Eurodollars-US dollars deposited in banks outside the US. and are free from US regulations

Question 23

Elements of Cash Cycle Formula

Answer 23