CH-10 Working Capital Flashcards
Formula for Cash Conversion Cycle
Days’ Inventory + Day’s A/R - Days’ Payable
Formula for Cash Turnover
365 / CCC
Collection Float for Paper Checks=
Time between payor mails the check and payee receives available funds
3 types of Collection Float
- Mail Float = mailed vs received
- Processing Float = e.g. lockbox processing
- Availability Float = deposit date vs credited to account and available
Final piece of operating cycle
Order-to-Cash period = Cash Inflow
Source Customer to Receive Payment
A decrease in AP results in a __ in cash OR a __ in debt
A decrease in AP results in a DECREASE CASH or an INCREASE DEBT
Which Financing Strategy uses ST Debt to finance permanent current assets?
Aggressive Strategy
Define Permanent Current Assets
the lowest amount of current assets a company has had in the past several years
How are Permanent Current Assets typically financed? Name financing strategies
Using LT Debt (Maturity-matching and Conservative financing strategies) Aggressive only use a portion of LT Debt
How are changes in working capital financed?
ST Debt
Another term for “changes in working capital”
Fluctuating Current Assets
What enables a firm to adjust the amount of financing to the fluctuation in current assets so it can minimize excess financing and avoid paying too much interest?
ST Debt
3 items that help Treasury determine the best financing strategy
- Current interest rates
- Forecast future rates
- Management’s risk tolerance
Which financing strategy has higher financing costs b/c it only finances a portion of fluctuating current assets with ST Debt?
Conservative
Relaxed Current Asset Investment Strategy =
Management maintains:
HIGH current assets relative to Sales.
Higher cash holdings
LIBERAL inventory management and credit policies. Lower investment returns, less operating risk.
Which financing strategies finance 100% fluctuating current assets with ST Debt?
Maturity-Matching and Aggressive
Which financing strategies finance 100% Permanent Current Assets with LT Debt?
Maturity-Matching and Conservative
Restrictive Current Asset Investment Strategy =
Management maintains: LOW current assets relative to sales. LESS cash TIGHT inventory management. RESTRICTIVE credit policy Higher profitability potential but MORE RISK due to inventory shortage, run out of cash, turn down acceptable credit risks
Which is a more volatile current asset investment strategy: relaxed or restrictive?
Restrictive Strategy is more volatile
Low reliance on ST Financing
(AKA High reliance on LT debt)
results in a __ current ratio, __ profits b/c ___
Low reliance on ST Financing results in a HIGHER Current Ratio, LOWER Profits b/c INCREASED INTEREST EXP
Define Trade Credit
Contract allows customer to take immediate possession of goods/services and pay for it later. Primarily offered to increase sales; creates A/R
2 stage process of Trade Credit
- Establish credit acceptance criteria
2. Set Credit Limit for each customer
5 C’s of Credit
- Character: payment history
- Capacity: liquidity resources
- Capital: ST and LT financial resources
- Collateral: available assets/guarantees
- Conditions: macroeconomic environment impacting ability to pay
Define Open Account
Customer takes immediate possession of goods/services. Seller issues invoice as obligation of AR for each transaction or monthly. Full payment within Credit Terms. Periodic creditworthiness review.
Most Common type of Commercial Trade Credit.
Most complex form of credit. When used?
Letter of credit. FI guarantees payment on behalf of the purchaser. Commonly used in Import/Export
Which type of Cash App system is most often used by B2C?
Balance-Forward System =
Payments are NOT matched to specific purchases (revolving credit, like retail credit cards)
Which type of Cash App system is most often used by B2B?
Open Item System =
payments matched to specific invoices per remittance. Payment discrepancies are researched
A company’s credit terms, sales, and collection patterns determine its level of _____
A/R.
Since A/R must be financed, a company’s ability to extend credit relates directly to its ability to borrow.
4 step credit scoring process
- Differentiate standard and high-risk accounts based on income, obligations, employment history
- Weight characteristics
- Set cutoff scores
- Analysis of scores that fall in between cutoff points
Define Seasonal-dated credit terms and list industries impacted
Seller agrees to accept payment at the END of Buyer’s Selling Season.
Impacts: toys, greeting cards, garden supplies, sporting goods, textbooks
What is the primary cost to weight against the cost of bad debt when assessing trade credit offering?
WACC - Carrying cost of ST borrowings
When are Cash Terms used, and how long does a buyer have to pay?
Buyer has 7-10 days to make payment. Cash Terms are used for sale of perishable items or when buyer doesn’t have credit history with seller
define Altman Z-Score
used in B2B quatitative credit scoring. Used public data to predict probability of business going bankrupt
What impedes B2B quantitative credit scoring?
Less Reliable sample sizes (than consumer models)
Define Re-invoicing
centralized monitoring and collecting international A/R to manage FX exposures
How is title and goods shipment handled in a Re-invoicing Center?
Title to the goods passes through the re-invoicing center, but the goods ship directly from the exporting subsidiary to the importing subsidiary.
Who must approve a re-invoicing center?
Establishing a re-invoicing center requires Local Gov’t and Tax Approval, and Negotiations with Tax Authorities in all involved countries to determine how the re-invoicing center is taxed
Define Netting
Netting is a payables system that reduces the number of cross-border payments by consolidation of funds denominated in different currencies
Who has to approve Netting and why?
Netting is approved by the country’s Central Bank or Gov’t b/c of tax consequences. Some countries only allow netting in a single currency.
Bilateral Netting =
purchases between 2 subsidiaries are netted against each other so only the net difference is transferred.
Does NOT require a central treasury center to clear the transactions.
Multilateral Netting =
more than 2 subsidiaries involved. Each sub informs central treasury of all cross-border payments through an electronic system. Central treasury makes FX conversions. Net amount transferred to each sub
(Intercompany for FX where least amount of physical cash exchanged)
4 Stipulations of Multicurrency Accounts
- Account is denominated in Base Currency
- Portfolio of currencies are accepted
- Spread or margin over the spot rate to use in exchanging each currency back to the base currency
- Value date to apply debits/credits for each transaction type and currency
Primary benefit of a Multicurrency Account
Simplify international working capital management by accepting a variety of currencies without having to manage the FX transaction risk.
(Translation risk must still be managed by company.)
T/F: Re-invoicing center assumes ALL currency exchange risks
True
T/F: Netting can be used with Third-parties
True, but not as common as I/C only
T/F: Netting cannot be used with Giro payments
True, netting CANNOT be used with Giro. Giro is like an ACH credit initiated by the payor
Define Leading
LEading = when a subsidiary’s currency is expected to DEpreciate relative to the parent’s base currency.
i.e. speed up payments from sub
Define Lagging
LAgging = when a subsidiary’s currency is expected to Appreciate relative to the parent’s base currency
i.e. slow down payments from sub
What is a key difference between Internal Factoring and Re-invoicing?
Re-invoicing takes title of the goods.
Internal Factoring does not take title of the goods.
Internal Factoring involves buying A/R from the exporting unit and collecting funds from the importing unit.
When does title transfer for supplier-managed replenishment inventory system?
@ shipping dock
When does title transfer for paid-on-production inventory process?
during manufacturing process
When is payment record created for paid-on-production inventory process?
based on usage of goods/services, not shipment
Advantages of Centralized AP Disbursement System
+Control
+Better Cash Position Info
+Concentrate excess cash
+Forecast accuracy
Disadvantages of Centralized AP Disbursement System
- less personal Payee relations
- potential delay in payment, lost discounts
- requires coordination between central AP and field
What is the ECA of the US?
ECA=Export Credit Agency
The US’s ECA is EXIM=Export-Import Bank of US
What does EXIM do?
EXIM=Export-Import Bank of US is the Export Credit Agency that provides buyer financing, export credit insurance, and access to working capital for US Exporters
An advantage of ST debt over LT debt
Can adjust financing to level of current assets to avoid excess financing
To determine ST vs LT funding, a Treasurer should determine/forecast 3 things:
- Current interest rates
- Forecast of future rates
- Management’s risk tolerance
Re-invoicing Center summary
Although the title to the goods passes through the re-invoicing center, the actual goods usually are shipped directly from the exporting subsidiary to the importing subsidiary. Establishing a re-invoicing center requires local government and tax approval and negotiations with tax authorities in all involved countries to determine how the subsidiary is taxed. One of the primary benefits of a re-invoicing center is the centralization of FX exposures, which allows for more effective financial risk management. Re-invoicing eases the implementation of leading and lagging arrangements.
