CF chapter 26

Question 1

Cash conversions cycle

Answer 1

Measure of the cash cycle

Question 2

Accounts receivable days (formula)

Answer 2

Accounts receivable / Average daily COGS

Question 3

Accounts payable days (formula)

Answer 3

Accounts payable / Average daily COGS

Question 4

Inventory days (Formula)

Answer 4

Inventory / Average daily COGS

Question 5

CCC formula

Answer 5

Inventory days + Accounts receivable days - Accounts payable days

Question 6

Overall net working capital (ONWC) formula

Answer 6

= short-term assets - short-term liabilities

Question 7

Trade credit

Answer 7

The credit that the firm extends to its customers (“afnemerskrediet”), or receives from its suppliers
(”leverancierskrediet”)

Question 8

why does trade credit exist

Answer 8

Simple and convenient to use, virtually no transaction costs

Flexible source of funds, can be used as needed

Sometimes only source of funding available to a firm

Question 9

Why do firms offer trade credit to begin with?

Answer 9

Serves as an indirect way to lower prices for certain customers (large volumes, excellent payment
track record)

Ongoing business relationship with its customers provides the supplier with superior information
about the credit quality of customers

Supplier may be able to seize the inventory as collateral in case the customer defaults

Question 10

Accounts receivable days

Answer 10

Average number of days that it takes the firm to collect its sales

Compare this to the overall credit terms

See if a trend can be identified

Question 11

Aging schedule

Answer 11

Categorizes the firm’saccount receivable by the number of days they have been on the firm’sbooks

In terms of the amount and/or the number of accounts

Shows accounts receivable by date

Question 12

Payment pattern

Answer 12

Provides information on the percentage of monthly sales that the firm collects in each month after
sale

If e.g. it is normal that 10% of sales are usually collected in the same month, 25% in two months, etc., it can be compared with the current payment pattern

Question 13

Stretching’ accounts payable

Answer 13

= ignoring a payment due period and deliberately pay later
◦ Such a ‘policy’ may be dangerous if suppliers respond with restricted payment terms such ‘cash on
delivery’(COD) or even ‘cash before delivery’ (CBD)

Question 14

Negative cash flowback shock

Answer 14

Firm may experience that cash flows are unexpectedly temporarily negative

Question 15

Seasonal patterns and/or positive/negative cash flow shocks cause short-term
financing needs, since

Answer 15

Extra investment in fixed assets and working capital is needed in order to accomodate these

Increased earnings follow these investments with a time delay

And this must be (temporarily) financed

Question 16

Extreme growth may even lead to unsustainable situations

Answer 16

Working capital investment is so high that it cannot be financed
◦ Firm may go bankrupt when creditors require immediate payment
◦ Even though the firm is (highly) profitable
10

Question 17

It can be argued that the short-term financing needs are due to

Answer 17

Increased fixed asset investment

Extra (net) working capital investment

Question 18

short term debt alternatives

Answer 18

Single, end-of-period payment loan:
Firm pays interest on the loan and pays back the principal at the end of the loan maturity
◦ Interest rate may be fixed or variable

Line of credit:
Bank agrees to lend a firm any amount up to a stated maximum

Firm decides to what extent to use this credit facility

Question 19

Golden” financing rule

Answer 19

Fixed assets + permanent NWC ‘should’ be financed with long-term capital (mix of equity and long-
term debt)
◦ Temporary NWC: finance with short-term debt

Question 20

Revolving vs evergreen line of credit

Answer 20

Revolving has an expiration date (e.g. 3 years) evergreen does not

Question 21

Bridge loan (short term debt alternative)

Answer 21

Short-term bank loan that is used to “bridge the gap” until the firm has arranged long-term financing

Question 22

Discount loan

Answer 22

Loan requiring the borrower to pay the interest at the beginning of the period

The lender deducts the interest from the loan proceeds

Question 23

Hidden costs

Answer 23

Besides interest, short-term loans have additional fees and restrictions

E.g. commitment fee for credit line
◦ Stated maximum of 1 million
◦ Interest rate 10% (EAR)
◦ Commitment fee is 0.50% (EAR) of the unused portion
◦ Firm borrows 800 000 at the beginning of the year and repays this at the end

Question 24

Loan origination fee (hidden costs)

Answer 24

Bank charge that the borrower must pay upfront

Suppose the firm is granted a 500 000 three month loan at an APR of 12%

Origination fee is 1% = 5 000

Question 25

Commercial paper

Answer 25

Short-term unsecured debt issued by large corporations directly to the investing
public

Question 26

Trust receipt loan

Answer 26

Distinguishable inventory items are held in a trust as security for the loan