Chapter 11 - Working Capital Metrics Flashcards
What do the fundamental working capital metrics advise on in terms of risk?
The anticipated default risk of the firm
What are some uses of monitoring working capital metrics?
Performance
Adjust payment terms
Forecast cash flows
Manage liquid resources
What does the Days Cash Held ratio show?
(and what are the downsides to using this metric?)
How many days the entity could survive paying cash operating expenses without any additional cash from revenues
Downside: Assumes expenses are incurred evenly; could be large payments right after balance sheet date
Is it always good to have really high working capital metrics?
It’s good to have a higher value, but you don’t want to overinvest in working capital as it becomes more expensive
How do you interpret the Cash Conversion Cycle’s calculation?
(how many days…)
How many days it took to recover each dollar invested in the production process
Does a change in the CCC necessarily mean the sales volume has increased?
No, it may mean that working capital is being used more efficiently
Two situations where it would be economical to forego the offered trade credit discount:
Must borrow at an interest rate that exceeds the discount
You can invest at a rate higher than the discount
When would you want to accept credit cards, even when the NPV is negative?
Accelerated cash receipts can be reinvested
Accepting cards may make it easier for customers to pay, increasing sales
Earlier cash collection reduces customer credit risk and the costs of cash collection
Why is Days Inventory tied to COGS?
Inventory is recorded at cost, not the sales value
What are two reasons sellers offer discounts?
Incentivize customers to payer faster
To stay competitive
What can you determine by reviewing individual accounts receivables?
Errors or delays or payment processes that are slowing collections
Customers that are intentionally delaying payment
A change in financial condition that may alter a customer’s ability to make timely payments
Two important items to monitor at the aggregate level for accounts receivable
Effectiveness of the application of payments
Overall level of write-offs or bad debt loss
If there are no cash sales, which two A/R related metrics will be the same?
Days Receivable
Days Sales Outstanding
What are examples of things that can distort Days Sales Outstanding?
Strong sales seasonality
Changing trends in sales volumes
Downsides to relying only on Days Sales Outstanding
Difficult to see trends
Difficult to see distribution of individual invoices that may be well past due
Are DSO and aging schedules subject to potential variances depending on accepted practices, industry norms, etc.?
Yes, it is important to understand what actually counts as past due
A/R Aging Schedule vs. A/R Balance Pattern
Aging Schedule indicates current and past-due receivables
Balance Pattern is used to monitor customer payment timing
What determines a firm’s normal balance pattern for the A/R Balance Pattern analysis?
Collection history
Is A/R Aging a good way to track individual accounts receivable?
Yes, it can be done at the aggregate or individual customer level
How would you convert an A/R Balance Pattern report into a collections report?
- Take 100% and subtract the outstanding amount for the first month
- For subsequent months, calculate the percentage difference in the A/R outstanding balance
What is a faster way to calculate a given month’s ending A/R balance when you are only given collection percentages?
(calculation question)
Add up the cumulative receipts percentage given the month of sales and the month of measurement and multiply by the sales value
