Chapter 10 - Introduction to Working Capital Flashcards
Four Types of Operating Cash Flows
- Cash Outflow
- Cash Inflow
- Internal Liquidity Management Flow
- External Liquidity Management Flow
Cash Flow Timeline’s Three Stages
Procure-to-Pay Period
Inventory Period
Order-to-Cash Period
Procure-to-Pay Timeline
The time between when raw materials are purchased and the point at which funds leave the firm’s bank account
Inventory Timeline
Turn raw materials into a finished product and then sell the good
Order-to-Cash Timeline
Sourcing customers through conversion of inventory to sales to the collection of cash
How is the Procure-to-Pay Timeline connected to the Inventory Timeline connected to the Order-to-Cash Timeline?
P2P –> Inventory = Receive goods and invoice to raw materials
Inventory –> O2C = Finished goods to send invoice
Entire Cash Flow Timeline Float Period
(When does it start and when does it end?)
Purchase of raw materials to payment received by customers
What is usually the biggest driver of float?
- Manual processes
- Inefficiencies
- Waiting on someone else to take action
Payment float is the least time-consuming portion of float
Unique corporate payment terms will always result in what with relation to working capital management?
Float
Payment Float for Seller/Payee
Time between when the invoice is sent to the buyer and the time that the payee’s account is credited
Payment Float for Buyer/Payor
Time between when invoice is received and account is debited
Collection Float
Time interval between the time the buyer/payor initiates payment and the time the seller payee receives good funds
Three Types of Collection Float
Mail Float
Processing Float
Availability Float
Mail float – interval between when the payment is mailed and when it is received
Processing float – interval between receiving payment and deposit is made
Availability float - interval between the day when a payment is deposited and the day when the payee’s account is credited with collected funds
What is the primary cost that should be considered with collection float and use of funds?
Opportunity cost of using that cash
Can float be applicable to electronic payments?
Yes
Disbursement Float
Time between when a payment is initiated and when it is debited from the account
Does prefunding ACH transactions impact float?
Yes
Invoicing Float
Interval between when the customer places an order and the day the customer receives an invoice
Payment Float
Interval between invoice being sent/received and the day the payment is credited to the biller’s bank account
What is usually the largest driver of Payment Float?
A customer’s payables policy
Information Float
Lack of knowledge about the funds and their availability
What are two examples of approaches or strategies that reduce overall float for working capital considerations?
JIT Inventory
Supply chain management
If a customer is using JIT Inventory or Supply Chain Management, they will likely do what with regards to paying and receiving?
Everything will be electronic as this outweighs the prior benefits of slowing payments and speeding up collections
Collection Float for the supplier is known as what for the buyer?
Disbursement float
Which float time interval is longer: (a) the seller’s payment float or (b) the buyer’s payment float?
Seller’s payment float because it starts when the invoice is sent, not received
In its simplest form, the CCC is the time period between what?
Disbursement for A/P and collection of A/R
Turning a cash outflow into a cash inflow
Days Inventory (DI)
Interval between purchase of raw materials and sale of finished goods
Days Receivable (DR)
Number of days required to collect on credit
Days Payables (DP)
Days between when purchase is made and when payment is made
Benefits of expanding Days Payable?
Reduce debt
Invest cash on a short-term basis
Make other purchases
If a purchaser has trade terms of net 30, will the Days Payable number usually be higher or lower?
Higher
A higher cash turnover ratio means a company is more or less efficient?
More efficient
Will changes in CCC related items impact the income statement or the overall sales process?
No
Will shortening the CCC increase or decrease NI?
Why?
Increase NI and lower inventory carrying costs
CCC changes will be short-lived if the following occur…
(Review Only)
- Lost sales due to overly strict credit and collection standards
- Production stoppages attributable to inadequate raw materials
- Payables stretched beyond the due date
- Forgone cost-saving trade discounts
- Higher prices assessed by suppliers because individual orders are smaller or payment is slower
- Refusal to sell to customers that are good credit risks, but occasionally slow in paying
- Excessive reliance on A/P in lieu of a stable base of short-term bank credit
Is WACC generally a good measure of opportunity cost of working capital considerations?
No, it is generally focused on long-term financing
Alternative to WACC for the opportunity cost rate as a net borrower?
Short-term borrowing rate
Alternative to WACC for the opportunity cost rate as a net investor?
Short-term investment rate
Current asset and current liability accounts that fluctuate with sales amounts are known as being…
(single adjective)
Spontaneous
Increase in noncash current assets must be supported by reducing [XXXXXXX] and increasing [XXXXXXX]?
Cash
Debt and other liabilities
What may increase in the short-term when sales slow?
Inventory
The total net increase in working capital represents what that the company must do?
Fund it using debt or equity
Two questions that Treasury should be concerned about regarding working capital:
- What is the appropriate level of working capital
- The methods required to finance the working capital
Restrictive vs. Relaxed Current Asset Investment Strategy
-
Restrictive
Lower current assets
More volatile
Higher potential profitability
Issues with suppliers, credit acceptance, and running out of cash -
Relaxed
Higher current assets
Reduces investment returns
Issues with higher level of current assets should sales levels fall
Are creditors influenced by a company’s current asset strategy?
(What two things will it impact?)
Yes, will determine interest rates and risk
Companies with high gross profits may have what type of current asset investment strategy?
Relaxed
What is the concept of permanent current assets?
Minimum amount of current assets required to do business
Serves as the foundation, with fluctuating fixed assets on top
Three Approaches for Current Asset Financing Strategies
Maturity-Matching
Conservative Financing Strategy
Aggressive Strategy
Maturity Matching Current Asset Financing Strategy
Funding permanent current assets and fixed assets with long-term financing and fluctuating currents assets with short-term debt
Conservative Current Asset Financing Strategy
- Funding permanent current assets, fixed assets, and a portion of fluctuating currents assets with long-term financing
- Highest financing costs – mitigated with fixed long-term borrowings and variable rate interest on short-term borrowings
Aggressive Current Asset Financing Strategy
- All fixed assets with long-term financing, but finances only a portion of permanent current assets with long-term financing
- Short-term rates are generally lower, but can fluctuate and also leaves the entity prone to more risk during uncertain times
- Liquidity risk with rollover
- May need to renegotiate the credit lines with higher fees
What is the annual cleanup period for a lender?
Short-term borrowers must completely pay off or clean up the outstanding balance at least once a year to prove it isn’t being used for long-term financing
A relaxed current asset investment policy and a conservative current asset funding strategy will result in what with regards to liquidity?
(What additional risk does this present for the firm?)
Excess liquidity at a higher cost
May be viewed as takeover targets
Three items to consider to help to determine which current asset financing strategy is best for the firm:
(think about what drives cost of financing)
Current interest rates
Future interest rates
Risk appetite of management
