CFA 39: Working Capital Management

Question 1

working capital management

Answer 1

Teh management of a company’s short-term assets (such as inventory) and short-term liabilities (such as money owed to suppliers).

Question 2

drag on liquidity

Answer 2

When receipts lag, creating pressure from the decreased available funds.

Question 3

pull on liquidity

Answer 3

When disbursements are paid too quickly or trade credit availability is limited, requiring compies to expend funds before they receive funds from sales that could cover the liability.

Question 4

credit-worthiness

Answer 4

The perceived ability of the borrower to pay what is owed on the borrowing in a timely manner and represents the ability of a company to withstand adverse impacts on its cash flows. Credit-worthiness allows the company to obtain lower borrowing costs and better terms for trade credit and contributes to the company’s investment flexibility, enabling it to exploit profitable opportunities.

Question 5

liquidity ratios

Answer 5

Measure a company’s ability to meet short-term obligations to creidtors as they mature or come due. Focuses on the relationship between current assets and current liabilities and the rapidity with which receivables and inventory can be converted into cash during normal business operation.

Question 6

current ratio

Answer 6

ratio of current assets to current liabilities

Question 7

quick ratio

Answer 7

ratio of quick assets to current liabilities

Question 8

quick assets

Answer 8

Those assets that can be most readily converted to cash.

Question 9

accounts receivable turnover

Answer 9

ratio of sales on credit to the average balance in accounts receivable

Question 10

inventory turnover

Answer 10

ratio of cost of goods sold to the balance in inventory

Question 11

number of days of receivables

Answer 11

number of days of the current asset or liability that are on hand; accounts receivable/ average day’s sales on credit

Question 12

number of days of inventory

Answer 12

length of time on average that the inventory remains within the company during the fiscal period

Question 13

number of days of payables

Answer 13

A measure of how long it takes the company to pay its own suppliers

Question 14

operating cycle

Answer 14

A measure of the time needed to convert raw materials into cash from a sale. It consists of the number of days of inventory and the number of days of receivables.

Question 15

net operating cycle (cash conversion cycle)

Answer 15

A measure of the time from paying suppliers for materials to collecting cash from the subsequent sale of goods produced from these supplies.

Question 16

target balance

Answer 16

A minimum level of cash to be held available - estimated in advance and adjusted for known funds transfers, seasonality, or other factors.

Question 17

discount interest

Answer 17

difference between the purchase price and the face value

Question 18

nominal rate

Answer 18

A rate of interest based on the security’s face value

Question 19

yield

Answer 19

Actual return on investment if it is held to maturity.

Question 20

passive strategy

Answer 20

Characterized by one or two diecision rules for making daily investments

Question 21

active strategy

Answer 21

Involves constant monitoring and may involve matching, misatching, or laddering strategies

Question 22

matching strategy

Answer 22

An active investment strategy that includes intentional matching of the timing of cash outflows with investment maturities.

Question 23

mismatching strategy

Answer 23

An active investment strategy whereby the timing of cash outflows is not matched with investment maturities.

Question 24

laddering strategy

Answer 24

A form of active strategy which entails scheduling maturities on a systematic basis within the investment portfolio such that investments are spread out equally over the term of the ladder.

Question 25

captive finance subsidiary

Answer 25

A wholly-owned subsidiary of a company that is established to provide financing of the sales of the parent company.

Question 26

credit scoring model

Answer 26

statistical model used to classify borrowers according to credit-worthiness

Question 27

float

Managing Accounts Receivable

Answer 27

amount of money that is in transit between payments made by customers and the funds that are usable by the company

Question 28

float factor

Answer 28

dividing the average daily deposit in dollars to the average daily float

Question 29

aging schedule

Managing Inventory

Answer 29

breakdown of the accounts into categories of days outstanding.

Question 30

transactions motive

Managing Inventory

Answer 30

In the context of inventory management, the need for inventory as part of the routine production-sales cycle

Question 31

precautionary stocks

Managing Inventory

Answer 31

A level of inventory beyond anticipated needs that provides a cushion in the event that it takes longer to replenish inventory than expected or in the case of greater than expected demand.

Question 32

stock-out losses

Managing Inventory

Answer 32

Profits lost from not having sufficient inventory on hand to satisfy demand.

Question 33

economic order quantity-reorder point (EOQ-ROP)

Managing Inventory

Answer 33

An approach to managing inventory based on expected demand and the predictability of demand; the ordering point for new inventory is determined based on the costs of ordering and carrying inventory, such that the total cost associated with inventory is minimized.

Question 34

anticipation stock

Managing Inventory

Answer 34

Inventory in excess of that needed for anticipated demand, which may fluctuate with the company’s sales or production seasonality.

Question 35

Just in Time Method (JIT)

Answer 35

A system that minimizes in-process inventory stocks - raw materials and in production - by evaluating the entire system of the delivery of materials and production. Materials are then reordered when a reorder point is reached.

Question 36

Manufacturing Resource Planning (MRP)

Answer 36

The incorporation of production planning into inventory management. A MRP analysis provides both a materials acquisition schedule and a production schedule.

Question 37

trade credit

Managing Accounts Payable

Answer 37

A spontaneous form of credit in which a purchaser of the goods or service is, effectively, financing its purchase by delaying the date on which the payment is made. May involve a discount for early payment such as 2/10 net 30.

Question 38

disbursement float

Managing Accounts Payable

Answer 38

The amount of time between check issuance and a check’s clearing back against the company’s account.

Question 39

committed lines of credit

Managing Accounts Payable

Answer 39

“regular” bank line of credit; unsecured and pre-payable without any penalties. Most common interest rates negotiated are borrowing at the bank’s prime rate or at a money market rate plus a spread.

Question 40

revolving credit agreements

Managing Accounts Payable

Answer 40

The strongest form of short-term bank borrowing facilities; they are in effect for multiple years (i.e. 3-5) and may have optional medium-term loan features.

Question 41

asset-based loans

Managing Short Term Financing

Answer 41

A loan that is secured with company assets.

Question 42

assignment of accounts receivable

Managing Short Term Financing

Answer 42

The use of accounts receivable as collateral for a loan.

Question 43

factor (i.e. to “factor” accounts receivable)

Managing Short Term Financing

Answer 43

A common or underlying element with which several variables are correlated.

Question 44

inventory blanket lien

Managing Short Term Financing

Answer 44

Lender has a claim on some or all of the company’s inventory, but the company can sell the inventory in the ordinary course of business.

Question 45

trust receipt arrangement

Managing Short Term Financing

Answer 45

Lender requires the company to certify that the goods are segregated and held in trust, with proceeds of any sale remitted to the lender immediately.

Question 46

warehouse receipt arrangement

Managing Short Term Financing

Answer 46

Similar to the trust receipt arrangement, but there is a third party (i.e. a warehouse company) that supervises the inventory.