Chapter 7: Current Asset Management Flashcards
Reasons for holding cash
Transaction balances: Payments towards planned expenses.
Compensating balances at banks:
Hold balances to compensate bank rather than paying directly for services
Precautionary needs: emergency (cash inflows less than projected)
Best for seasonal or cyclical industries (inflows more uncertain)
Main goal in managing receivable and inventory
Investment level should not be result of happenstance or historical determination.
Must meet same return-on-investment criteria applied to any decision.
Main goal in managing cash and marketable securities
Primary concern is safety and liquidity.
Secondary attention is on maximizing profitability.
Cash management
keep to min
help improve profit of firm by keeping to min and knowing when cash flow in/out
What is the cash flow cycle
The pattern in which cash moves in and out of the firm.
The primary consideration in managing the cash flow cycle is to ensure that inflows and outflows of cash are properly synchronized for transaction purposes.
Basis of cash flows
Customers ->
Sales -> Accounts receivables -> Cash -> Inventory
What is the float?
The difference between the corporation’s recorded cash balance on its books and the amount credited to the corporation by the bank.
Types: mail , clearing (check)
Check 21 Act impact
Allows banks and others to electronically process checks.
Float will eventually be eliminated altogether.
How to improve collections and extend disbursements
Improving collection.
Setting up multiple collection centers at different locations.
Adopt lockbox system for fast check clearance at lower costs.
Extending disbursement.
General trend.
Speed up processing of incoming checks.
Slow down payment procedures.
Cost/Benefit Analysis
Expenses from use of remote collection and disbursement centers involve additional costs.
Expenses must be compared to benefits that may accrue through use of these operations.
What are Electronic funds transfer (EFTs)
A system in which funds are moved between financial institutions using computers.
What is Automated clearinghouses
An ACH transfers information between one financial institution and another and from account to account via computer tape.
P2P transafers fastest growing
What are International electronic funds transfer carried out through S W I F T
Proprietary secure messaging system.
Encrypts each message.
Authenticates every money transaction.
Assumes financial liability for accuracy, completeness, and confidentiality of transaction.
International Cash Mgmt - WHat is a sweep account?
Allows companies to maintain zero balances.
Excess cash swept into interest-earning account
When to use Marketable securities
Convert cash into interest earning marketable securities when being held for non-transaction purposes
Factors to consider for marketable securities
yield, maturity, min investment, safety, and marketability
Accounts Receivable as an investment
Based on whether level of return on investment equals or exceeds potential gain from other investments.
Optimizing return based on appropriate risk and liquidity considerations.
Credit policy administration has three primary policy variable
Credit standards.
Terms of trade.
Collection policy.
Credit Standards
Determine nature of credit risk based on.
Prior records of payment, financial stability, current net worth, other related factors.
5 cs of credit:
Character.
Capital.
Capacity.
Conditions.
Collateral.
Inventory Mgmt
Raw materials, WIP, FInished goods
Inventory impacted by: sales, production, economic conditions
inventory least liquide SHOULD = highest yield
Level Production
Allows maximum efficiency in manpower and machinery usage.
May result in high inventory buildup before shipment, particularly in seasonal business.
Seasonal production.
Eliminates inventory buildup problems.
May result in unused capacity during slack periods.
May result in overtime wages and inefficiencies arising out of overused equipment.
Inventory costs =
Carrying costs: costs to hold an asset, usually inventory
Ordering costs: expenditure for acquiring new inventory.
Economic ordering quantity:
The most efficient ordering quantity for the firm. The EOQ will allow the firm to minimize the total ordering and carrying costs associated with inventory. (M)
What are stockouts? How to helP?
Stockout occurs when firm is:
Out of specific inventory item.
Unable to sell or deliver product
Help: safety stock
Increases cost of inventory due to rise in carrying costs.
Cost should be offset by:
Eliminating lost profits due to stockouts.
Increased profits from unexpected orders.
Basic requirements for J I T.
Quality production that continually satisfies customer requirements.
Close ties among suppliers, manufacturers, and customers.
Minimizes level of inventory.
Savings and Downsides of JIT
Lower level of inventory + reduced financing costs
Avg reduced inventory to sales ratios by over 10%
May push cost of financing to supplier -> impose JIT on supplier for more leaner production system
Downside:
SHortages or surplus
Modos Company has deposited $3,500 in checks received from customers. It has written $1,400 in checks to its suppliers. The initial bank and book balance was $600. If $1,600 of its customers’ checks have cleared, but only $600 of its own, calculate its float.
Bank balance = $600 + $1.600 − $600 = $1,600
Book balance = $600 + $3,500 − $1,400 = $2,700
Float = $1,100
If average daily remittances are $6 million, and “extended disbursement float” adds two days to the disbursement schedule, how much should the firm be willing to pay for a cash management system if the firm earns 7% on excess funds?
Annual return from cash management system = $6,000,000 × 2 days × 7% = $840,000
Float takes place because
a lag exists between writing a check and clearing it through the banking system.
Cash flow does relies on
The payment arrangements of customers.
The speed at which suppliers and creditors process checks.
The efficiency of the banking system.
International cash management is more complex than domestic-based cash management because of
liquidity management issues.
different banking systems.
currency fluctuation risk
Which of the following securities represents an unsecured promissory note issued by a corporation?
Commercial paper
Generally, the safest and most marketable instrument for short-term investment is
t bills
Characteristics of a money market deposit account include
a lower risk than money market funds.
insurance by federal agencies.
generally a limit of three deposits or withdrawals per month.
Money market funds are
accounts that allow small investors to participate in buying large-denomination securities.
the purchase of shares by investors, the proceeds of which are reinvested into liquid short-term securities.
The most subjective and significant segment of the 5 Cs of credit for giving final approval is
character.
Which of the following is a valid quantitative measure for accounts receivable collection policies?
Average collection period
Aging of accounts receivables
Ratio of bad debts to credit sales
A banker’s acceptance
is a draft drawn on a bank and paid by that bank when presented to it.
may be accepted by the bank for future payment.
can be traded in a relatively liquid market until maturity.
Dun & Bradstreet is known for providing
credit scoring reports that rank a company’s payment habits relative to its peer group.
When developing a credit scoring report, many variables would be considered. Which of the following best represents the major factors Dun & Bradstreet would examine?
The financial statements, satisfactory or slow payment experiences, and negative public records (suits, liens, judgments, and bankruptcies).
Use of the economic order quantity
provides the lowest overall inventory costs.
costs are minimized when total carrying costs and total ordering costs are equal.
The costs of carrying inventory include
the interest on funds tied up in inventory.
the cost of warehouse space
insurance and handling costs.
For a given firm, holding other factors constant, ordering costs per unit generally
decline as average inventory increases.
We expect that we can receive annual incremental income after taxes of $25,000, including an adjustment for uncollectible accounts. What is the maximum commitment to A/R that we should be willing to assume if our firm’s minimum required after-tax return is 8%?
Incremental ROI=Net Income/Average Investment
8%=$25,000/Average Investment
Average Investment = $312,500
The amount of safety stock that a firm carries depends upon
the predictability of inventory usage and the time period necessary to fill inventory orders.
