chapter 26 Flashcards
net working capital components
cash, inventory, receivables, and payables. it does not include excess cash.
excess cash
cash that is not required to run the business and can be invested at the market rate.
cash cycle
the length of time between when the firm pays cash to purchase its initial inventory and when it receives cash from the sale of the output produced from that inventory.
operating cycle
the average length of time between when a firm originally purchases its inventory and when it receives the cash back from selling its product. if the firm pays cash for its inventory, this is identical to the cash cycle.
working capital level
reflects the length of time between when cash goes out of a firm at the beginning of the production process and when it comes back in.
trade credit
the credit the firm extends to its customers when a firm allows a customer to pay for goods at some date later than the date of purchase, creating an account receivable for the firm and an account payable for the customer. it is in essence a loan with the price discount as interest rate.
terms of trade credit
eg. 2/10, Net 30. meaning 2% discount if paid within 10 days and full amount due at 30 days.
cost of the discount
for the selling firm equals the discount percentage times the selling price.
processing float
how long it takes the firm to process the check and deposit it in the bank.
collection float
the amount of time it takes for a firm to be able to use funds after a customers has paid for its goods.
mail float
how long it takes the firm to receive the check after the customer has mailed it.
availability float
how long it takes before the bank gives the firm credit for the funds.
disbursement float
the amount of time it takes before payments to suppliers result in a cash outflow for the firm. it is a function of mail time, processing time, and checking and clearing time.
accounts receivable days
a tool to monitor accounts receivable after establishing a credit policy to see if it is working effectively. a firm can compare this number to the payment policy specified in credit terms and look at the trend over time.
aging schedule
categorises accounts by the number of days they have been on the firm’s books. it can be prepared using the number of accounts or dollar amount of accounts receivable outstanding.
‘bottom-heavy’ aging schedule
an aging schedule where the percentages in the lower half of the schedule begin to increase. in this case the firm needs to revisit its credit policy.
payment pattern
provides information on the percentage of monthly sales that the firm collects in each month after the sale. an analysis of payment pattern can augment the aging schedule.
stretching accounts payable
a practice where the firm ignores the payment due period and pays later. doing this reduces the direct cost of trade credit because it lengthens the time that a firm has use of the funds.
stock-out
the situation when a firm runs out of goods and loses sales because too little inventory is held.
acquisition costs
the costs of the inventory itself over the period being analysed (usually one year).
carrying costs
include storage cost, insurance, taxes, spoilage, obsolescene, and the opportunity cost of the funds tied up in inventory.
‘just-in-time’ (JIT) inventory management
when a firm acquires an inventory precisely when needed so that the inventory balance is always zero, or very close to it. it requires exceptional coordination with suppliers and a predictable demand. firms seek to reduce their carrying costs as much as possible.
transactions balance
the amount of cash a firm needs to be able to pay its bills.
precautionary balance
the amount of cash a firm holds to counter the uncertainty surrounding its future cash needs.
compensating balance
an account at the bank as compensation for services that the bank performs. they are usually deposited in accounts with no or very low interest.
money market securities
short-term debt securities a firm may invest in directly or through money market mutual funds. they are liquid with low default risk.
quick ratio
a common measure used to assess whether the firm has adequate liquidity to meet short-term needs. it is the ratio of current assets other than inventory to current liabilities.
treasury bills
short-term debt of the US government. it is default risk free, very liquid and marketable.
certificates of deposit (CDs)
short-term debt issued by banks with a minimum denomination of $100,000. they are insured to be default risk free up to $250,000 and less liquid than treasury bills.
repurchase agreements
a loan arrangement whenin a securities dealer is the “borrower” and the investor is the “lender”. the investors buys securities from the securities dealer with an agreement to see them back to the dealer at a later date for a specified higher price. very little risk, as the security is collateral for the loan.
banker’s acceptances
drafts written by the borrower and guaranteed by the bank on which the draft is drawn. typically used in international trade transactions; the borrower is an importer who writes the draft in payment of goods. very little risk because both the borrower and bank guaranteed the draft.
commercial paper
short-term, unsecured debt issued by a large corporation. the minimum denomination is $25,000. the default risk depends on the creditworthiness of the issuing corporation.
short-term tax exempts
short-term debt of state and local governments. these instruments pay interest that is exempt from federal taxation, so the pre-tax yield is lower than those of a similar-risk, fully taxable investment. the default risk depends on the creditworthiness of the government.
