Ch 2, Module 5 Flashcards
What are the motives for holding cash
- transaction motive: meet pmts arsing from the ordinary course of business
- Speculative motive: can may be needed to take advantage of temporary opportunities
- Precautionary motive: have enough cash on hand to maintain a safety cushion to meet unexpected needs
What are the disadvantages of high cash levels
decreased ROA
- negative arbitrage effect (i.e. interest obligations exceed interest income from cash reserves - you’d be better off just taking that money and paying off debt)
- increased attractiveness as a takeover target
- investor dissatisfaction with allocatino of assets (i.e. failure to pay dividends)
What are the primary methods of increasing cash levels
-reducing the operating cycle (sell and collect quickly - either speeding up cash inflows or slowing down cash outflows increases cash balances)
What is the credit period
the length of time you give your customers to pay you
- if its too long you may experience cash shortages
- if its too short you may damage relatinshiop with customers and negatively affect future sales
Define credit standards
extending credit to only financially strong customers minimizes uncollectible receivables BUT also limits potential sales
extending credit to a broader base of customers increases sales BUT adds risk in that a greater percentage of receivables are likely to be written off
Define collection policy
how stringent or lax will you be in collecting delinquent accounts
What are methods to speed up collections of AR
- customer screening and credit policy: choose to extend credit to more repsonsible customers, who are more likely to pay bills promptly
- Prompt billing: timely billing of charges to credit customers ultimately serves to speed collections
- Payment discounts: offering payment discounts may influence customers to pay faster and can result in improved cash collections (1/10, n/30)
- expedite deposits: (only when the benefit > costs) electronic funds transfer or lockbox system
- concentration banking: characterized by the designation of a SINGLE bank as a central depository
Define factoring
Factoring A/R entails turning over the collection of A/R to a 3rd party factor in exchange for a discounted short term loan. Cash is collected from the factor immediately rather than from the customer according to the credit terms.
Define a “letter of credit”
lowers your cost of borrowing
its a third party guarantee (bank!)
represent an external credit enhancement used be a company issuing otherwise unsecured debt to enhance its credit or can be required by a creditor to ensure payment.
Define “line of credit”
ie bank loan
represents a revolving loan with a bank that is up to a specific dollar maximum amount for a defined term
Define “borrowing capacity”
goes up if you have a relatively low debt:equity
represents the amount of money in the form of credit or loans that a given lender like a bank is willing to extend to you
credit ratings are affected by income level and stability which in turn affect borrowing capacity
Define debt covenant
creditors use debt covenants in lending agreements to protect their interests by limiting or probi iting the actions of debtors that might negatively affect the positions of the creditors
protect borrower’s credit rating (and thus reduce their cost of borrowing)
convenants contained in a lending agreement may be positive or negative
define “positive covenant”
may include requirement that the issuer provides quarterly financial reporting (info) to the investors
Things that the borrower must/should do
things you promise to do
maintain certain ratios
Define “negative covenant”
involves a restriction on things the borrower is not allowed to do
things you won’t do (won’t pay excessive dividends, limitation on issuing additional debt)
i.e. restriction on asset sales for a stipulated time frame
What happens if you violate a debt covenant
the debtor is in “technical default” and theoretically the creditor can demand repayment of the ENTIRE principal. Typically concessions are are negotiated and real default, as opposed to technical default, is avoided
