Chapter 17

Question 1

Gross Working Capital

Answer 1

Total Current Assets

Question 2

Net Working Capital

Answer 2

Current Assets minus non-interest bearing liabilities

Question 3

Working Capital Policy

Answer 3

Deciding the level of each type of current asset to hold, and how to finance current assets

Question 4

Working Capital Management

Answer 4

Controlling cash, inventories, A/R, short-term liability management

Question 5

Why is it important to manage working capital?

Answer 5

Trade-off:
Working Capital=Current Assets that are necessary to conduct business. The greater the holding of current assets, the smaller the danger of running out. However, holding working capital is costly (opportunity cost, and non-returning assets with costs such as storage).
Management needs to keep a fine balance in keeping the right amount of working capital. There is pressure to hold the amount of working capital to the minimum consistent with running the business without interruption.

Question 6

Moderate Policy

Answer 6

Match the maturity of assets to the maturity financing

Question 7

Aggressive Policy

Answer 7

Use short-term financing to finance permanent assets

Question 8

Conservative Policy

Answer 8

Use permanent capital to finance temporary and permanent assets

Question 9

Permanent Current Assets

Answer 9

Current assets company must carry even at the trough of its cyces

Question 10

Temporary Current Assets

Answer 10

Current assets that fluctuate with seasonal variations in sales i.e inventories, receivables

Question 11

Cash Conversion Cycle

Answer 11

The length of time it takes to turn the cash investment into cash in the form of collections from the sale of inventory. High conversion cycle means a greater need for external financing.

Question 12

Inventory Conversion Period

Answer 12

Average time required to convert raw materials into finished goods and then to sell them

Question 13

Receivables Collection Period (DSO)

Answer 13

Average length of time to convert receivables into cah

Question 14

Payables Deferral Period

Answer 14

Average length of time between purchase of resources and the payment of cash for them

Question 15

Why hold cash?

Answer 15

Transactions - You must have some cash to operate
Reservations - “Safety stock”. Reduced by credit lines and marketable securities
Compensating for loans and services provided
Speculation to take advantage of bargains and discounts. Reduced by credit lines and marketable securities.

Question 16

Goal of cash management

Answer 16

To meet the previous objectives and to have cash for transactions, yet not have excess cash.
To minimize transaction balances.

Question 17

Minimize cash holdings

Answer 17

Use a lockbox (?)
Insist on wire transfers from customers
Synchronize inflow and outflows
Use a remote disbursement account
Reduce need for "safety stock" or cash
-Line of Credit
-Hold marketable securities
-Increase forecast accuracy

Question 18

Cash Budget

Answer 18

Forecasts inflows, outflows, ending cash balances

Used to plan loans needed or funds available to invest

Question 19

How could bad debts be worked into cash budget?

Answer 19

Collections would be reduced. Lower collections would lead to higher borrowing requirements.

Question 20

Should depreciation be included in cash budget?

Answer 20

No. Depreciation is a non-cash charge. Only cash payments and receipts appear on a cash budget.

Question 21

Why would firms want to maintain a relatively high amount of cash?

Answer 21

If sales turn out to be considerable less than expected, the firm could face a cash shortfall. It may hold more cash if they do not have much faith in sales forecast, or is very conservative. Cash may be used to fund future investments.

Question 22

Inventory Management

Answer 22

Heavily dependant on sales. Difficult to establish a target inventory level if a firm has unpredictable sales.

Question 23

Inventory Cost - Carrying Cost

Answer 23

Storage and Handling Costs, Insurance, Property Taxes, Depreciation and Obsolescence

Question 24

Inventory Cost - Ordering costs

Answer 24

Cost of placing orders, shipping & handling

Question 25

Inventory Costs - Cost of running short

Answer 25

Loss of sales or customer goodwill, disruption of production schedules

Question 26

Reducing Inventory Levels

Answer 26

Reduces carrying costs, increases ordering costs and increases cost of running short

Question 27

Holding too much inventory reduces

Answer 27

ROE (Return on Equity) and EVA (economic value added)

Question 28

Reducing Inventory causes

Answer 28

Short-Run: Cash will increase

Long-Run: Invest cash in more productive assets and increase EVA

Question 29

Receivables Management

Answer 29

Firms would rather sell for cash than on credit, but competitive pressures force most firms to receive on credit. Carrying receivables has both direct and indirect costs, but it also has a benefit of increased sales.

Question 30

Amount of Receivables depend on

Answer 30

Volume of credit sales

Length of time between sales and collections

Question 31

Credit Policy

Answer 31

Tighten it to lower DSO or force customers to pay quicker

Question 32

Elements of Credit Policy

Answer 32

Credit Period (shorter may reduce DSO but might discourage sales)
Cash Discounts (increases sales)
Credit Standards (reduces sales AND bad debt)
Collection Policy (tough collection policy will reduce dso but damage customer relationships)

Question 33

If reduce DSO without adversely affecting sales

Answer 33

Short Run: Cash will increase

Long Run- Invest cash in more productive assets and increase EVA

Question 34

Short-term credit

Answer 34

Debt scheduled for repayment within a year
(accounts payables aka trade credit, bank loans, commercial loans, accruals) Riskier than L-T length as always required to pay.

Question 35

Advantages of short-term financing

Answer 35

Speed, Flexibility, Lower Cost than Long term debt

Question 36

Disadvantages of short-term financing

Answer 36

Fluctuating interest expense, default risk

Question 37

Trade Credit

Answer 37

Credit furnished by a firm’s suppliers. Longest source of short-term credit. Spontaneous source of funds but cost can be high though easy to get.

Question 38

Cost of Trade Credit

Answer 38

Credit is FREE during the discount period. If firm pays after discount expires, the cost of trade credit is the discount forgone.

Question 39

Bank Loan - Simple Annual Interest

Answer 39

No discount/Add On

Question 40

Bank Loan - Discount Interest

Answer 40

Discount = Deducted from loan amount

Question 41

Bank Loan - Compensating Balance

Answer 41

A bank balance that a firm must maintain to compensate the bank for granting a loan. Effective cost is interest/amountneeded.

Question 42

Bank Loan - Instalment Loan, add on

Answer 42

Add the interest from the loan