Chapter 7: Current Asset Management

Question 1

Reasons for holding cash

Answer 1

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)

Question 2

Main goal in managing receivable and inventory

Answer 2

Investment level should not be result of happenstance or historical determination.

Must meet same return-on-investment criteria applied to any decision.

Question 3

Main goal in managing cash and marketable securities

Answer 3

Primary concern is safety and liquidity.
Secondary attention is on maximizing profitability.

Question 4

Cash management

Answer 4

keep to min

help improve profit of firm by keeping to min and knowing when cash flow in/out

Question 5

What is the cash flow cycle

Answer 5

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.

Question 6

Basis of cash flows

Answer 6

Customers ->
Sales -> Accounts receivables -> Cash -> Inventory

Question 7

What is the float?

Answer 7

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)

Question 8

Check 21 Act impact

Answer 8

Allows banks and others to electronically process checks.
Float will eventually be eliminated altogether.

Question 9

How to improve collections and extend disbursements

Answer 9

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.

Question 10

Cost/Benefit Analysis

Answer 10

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.

Question 11

What are Electronic funds transfer (EFTs)

Answer 11

A system in which funds are moved between financial institutions using computers.

Question 12

What is Automated clearinghouses

Answer 12

An ACH transfers information between one financial institution and another and from account to account via computer tape.

P2P transafers fastest growing

Question 13

What are International electronic funds transfer carried out through S W I F T

Answer 13

Proprietary secure messaging system.
Encrypts each message.
Authenticates every money transaction.
Assumes financial liability for accuracy, completeness, and confidentiality of transaction.

Question 14

International Cash Mgmt - WHat is a sweep account?

Answer 14

Allows companies to maintain zero balances.
Excess cash swept into interest-earning account

Question 15

When to use Marketable securities

Answer 15

Convert cash into interest earning marketable securities when being held for non-transaction purposes

Question 16

Factors to consider for marketable securities

Answer 16

yield, maturity, min investment, safety, and marketability

Question 17

Accounts Receivable as an investment

Answer 17

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.

Question 18

Credit policy administration has three primary policy variable

Answer 18

Credit standards.
Terms of trade.
Collection policy.

Question 19

Credit Standards

Answer 19

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.

Question 20

Inventory Mgmt

Answer 20

Raw materials, WIP, FInished goods

Inventory impacted by: sales, production, economic conditions

inventory least liquide SHOULD = highest yield

Question 21

Level Production

Answer 21

Allows maximum efficiency in manpower and machinery usage.

May result in high inventory buildup before shipment, particularly in seasonal business.

Question 22

Seasonal production.

Answer 22

Eliminates inventory buildup problems.

May result in unused capacity during slack periods.

May result in overtime wages and inefficiencies arising out of overused equipment.

Question 23

Inventory costs =

Answer 23

Carrying costs: costs to hold an asset, usually inventory

Ordering costs: expenditure for acquiring new inventory.

Question 24

Economic ordering quantity:

Answer 24

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)

Question 25

What are stockouts? How to helP?

Answer 25

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.

Question 26

Basic requirements for J I T.

Answer 26

Quality production that continually satisfies customer requirements.
Close ties among suppliers, manufacturers, and customers.
Minimizes level of inventory.

Question 27

Savings and Downsides of JIT

Answer 27

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

Question 28

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.

Answer 28

Bank balance = $600 + $1.600 − $600 = $1,600

Book balance = $600 + $3,500 − $1,400 = $2,700

Float = $1,100

Question 29

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?

Answer 29

Annual return from cash management system = $6,000,000 × 2 days × 7% = $840,000

Question 30

Float takes place because

Answer 30

a lag exists between writing a check and clearing it through the banking system.

Question 31

Cash flow does relies on

Answer 31

The payment arrangements of customers.

The speed at which suppliers and creditors process checks.

The efficiency of the banking system.

Question 32

International cash management is more complex than domestic-based cash management because of

Answer 32

liquidity management issues.

different banking systems.

currency fluctuation risk

Question 33

Which of the following securities represents an unsecured promissory note issued by a corporation?

Answer 33

Commercial paper

Question 34

Generally, the safest and most marketable instrument for short-term investment is

Answer 34

t bills

Question 35

Characteristics of a money market deposit account include

Answer 35

a lower risk than money market funds.

insurance by federal agencies.

generally a limit of three deposits or withdrawals per month.

Question 36

Money market funds are

Answer 36

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.

Question 37

The most subjective and significant segment of the 5 Cs of credit for giving final approval is

Answer 37

character.

Question 38

Which of the following is a valid quantitative measure for accounts receivable collection policies?

Answer 38

Average collection period

Aging of accounts receivables

Ratio of bad debts to credit sales

Question 39

A banker’s acceptance

Answer 39

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.

Question 40

Dun & Bradstreet is known for providing

Answer 40

credit scoring reports that rank a company’s payment habits relative to its peer group.

Question 41

When developing a credit scoring report, many variables would be considered. Which of the following best represents the major factors Dun & Bradstreet would examine?

Answer 41

The financial statements, satisfactory or slow payment experiences, and negative public records (suits, liens, judgments, and bankruptcies).

Question 42

Use of the economic order quantity

Answer 42

provides the lowest overall inventory costs.

costs are minimized when total carrying costs and total ordering costs are equal.

Question 43

The costs of carrying inventory include

Answer 43

the interest on funds tied up in inventory.

the cost of warehouse space

insurance and handling costs.

Question 44

For a given firm, holding other factors constant, ordering costs per unit generally

Answer 44

decline as average inventory increases.

Question 45

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%?

Answer 45

Incremental ROI=Net Income/Average Investment

8%=$25,000/Average Investment

Average Investment = $312,500

Question 46

The amount of safety stock that a firm carries depends upon

Answer 46

the predictability of inventory usage and the time period necessary to fill inventory orders.