D. Managing cash and working capital Flashcards
1
Q
Where can entities obtain short term finance?
A
- commercial and corporate banks
- non-banking fin institutions e.g short term loan providers
- trading partners
2
Q
What are commercial and corporate banks?
A
- provide financial products to customers for profit
- accept deposits and provide loans/overdrafts
3
Q
What are non-financial institutions?
A
- main operating activity is not to provide finance
- use surplus cash to invest in shares/debentures
4
Q
How can trading partners help with finance?
A
- formal trade agreement
- between exporters and importers
- topical for Brexit
5
Q
What are the main types of short-term finance?
A
- TP
- factoring or invoice discounting of TR
- bank overdrafts and short-term loans
- financing exports
6
Q
How can trade payables be used as a source of short-term finance?
A
- delaying payment
- ‘fund’ inventory through suppliers
- to max benefit, pay as late as possible
- weigh discount against cost of borrowing
7
Q
Benefits of paying suppliers late?
A
- alleviated cash flow difficulties
- cash can earn a return
8
Q
Problems when paying late?
A
- loss of settlement discount
- poor credit rating
- supplier may stop further supplies
- increase in future selling prices
- legal action
9
Q
What is one of the benefits of trade credit?
A
no interest cost
- may charge interest once deadline has passed, unlike banks
- supermarkets use:pay when good is resold
10
Q
What is factoring?
A
take on responsibility to collect debt by offering 3 services:
- debt collection:credit control
- financing:funds provided before debt is collected
- credit insurance:take responsibility for irrecoverable debt
11
Q
What is invoice discounting?
A
- provided by factoring entity
- sell unpaid invoices to lender
- confidential service
12
Q
What are the benefits of bank overdrafts as short-term cash requirement?
A
- flexible
- only pay for what is used, so generally cheaper
13
Q
What are the disadvantages of bank overdrafts as short-term cash requirement?
A
- repayable on demand
- may require security
- variable finance costs
14
Q
What are bank loans?
A
- contractual agreement for a specific fund, period and interest rate
- less flexible than overdraft
- provide greater security than overdraft
15
Q
What are some methods available for dealing with the problems of financing exports and controlling the credit risk?
A
- bills of exchange
- forfaiting
- export factoring
- documentary credits
16
Q
What are documentary credits?
A
- letter of credit from issuer
- guarantees payment for exporter, provided exporter complies with certain requirements
- document issued by bank and authorises foreign exporter to withdraw money when conditions are met
17
Q
What is a bill of exchange/acceptance credit?
A
- binds one party to pay another on a fixed date
- similar to post-date cheques
- supplier (drawer) can draw a bill of exchange on customer (drawee)
- customer signs and acknowledges the debt exists and commits to paying it
18
Q
What are the two types of a bill of exchange?
A
- a slight draft/bill-payable immediately
- a time draft/bill-predetermined date of payment
19
Q
How can a time draft help with financing?
A
holder of the bill can use an accepted time draft to pay a 3rd party debt or can discount it to raise cash
20
Q
What is a significant characteristic of bills of exchange?
A
- drawee given a period of credit before having to pay a term bill
- drawee/payee can obtain payment earlier than the bill’s maturity date by means of discounting bill
21
Q
What happens when a bill of exchange is discounted?
A
- sold to financial markets at a discount to face value
- size of discount reflects the rate of interest that the buyer of the bill required from holding bill to maturity
22
Q
What is export factoring?
A
- factoring organisation agrees to factor the client’s export
- factor’s services include admin of the receivables ledger and collecting payment and factor finance
- factor buys overseas receivable for a lump sum < debt
- factor expertise can be helpful, especially for SMEs
23
Q
What is forfaiting?
A
- same as export factoring but seller will receive 100% of receivable as a lump sum
- exporter draws up bill of exchange from an importer
- bill of exchange is purchased by forfaiting comp (typically banks) without recourse to exporter
- exporter received total amount owed, forfaiter chases debt directly
- exporter has obtained payment for the goods without risk
24
Q
What are the key features of forfaiting?
A
- importer obtains medium-term finance for much of the purchase cost of the goods
- exporter receives immediate payment
- credit risk is accepted by the forfaiting bank, although the risk is reduced by the guarantee of the promissory notes (bille of exchange/acceptance credit)
25
Why might a business make short-term investments?
- money in day account makes no interest
| - can maximise profits if they gain returns
26
What are some short-term interest-earning investments cash surpluses can be spent on?
- interest-bearing bank accounts
- negotiable instruments
- short-dated government bonds
- other short-term investments
27
What criteria should be considered when making investment decisions?
- maturity
- return
- risk
- liquidity
- diversification
28
What is maturity?
short-term investment interest received on 'maturity'
29
What is a return?
interest yield on investment
30
What is risk a business should consider when investing?
-high risk, high return e.g shares
31
What is liquidity of investment?
how easily investment can be cashed in without significant loss of value
- short term are less liquid than keeping in bank
- art is illiquid and long term investment
32
How essential is diversification of investments for short term vs long term investments?
-less essential for investing short-term cash surpluses than long-term in equities and bonds
33
What are the two types of interest bearing accounts?
- bank deposit accounts
| - money market deposits
34
What is a bank deposit account?
- some are instant access, highly liquid
- some allow withdrawal without notice
- some require notice period before withdrawal
35
What is a money market deposit?
amounts of money deposited through a bank in the money markets
- markets for short term borrowing and lending
- attractive interest yields
- cant be withdrawn until deposit matures
- short term investments should be large amounts to reap benefits
36
Interest earned calculation?
amount deposited x annualized interest rate x (number of days interest earned/annual day count)
37
What are negotiable instruments?
financial instruments that may be obtained as investments
| -can easily be sold by one person to another
38
What are some examples of negotiable instruments?
```
bank notes
bearer bonds
Certificates of Deposit
bills of exchange
treasury bills
```
39
What are the most negotiable instruments as short-term investments
Certificates of Deposit
Treasury bills
bills of exchange
40
What is a Certificate of Deposit?
- evidence of a short-term deposit with a bank for a fixed term and earning a specified amount of interest
- amount is 100k<
- holder of the CD at maturity has the right to take the deposit with interest
- present to a bank who will collect it from bank holding instrument
- cant withdraw before maturity
- can sell CD if cash is needed early
41
What are investment yields on CDs?
- CDs are negotiable instruments
- can be sold unlike money market deposits
- therefore, yields are slightly lower on CDs
42
Bills of exchange as negotiable instrument?
- discount market is active money market for bills
- investor can buy bills
- eligible bank bills are payable by top quality banks
43
What are treasury bills?
- maturity of less than a year (most have 3 months)
- used by govt for short-term cash requirements
- have high credit quality, low risk and yield as govt backed
- redeemable at face value
- attractive as they are risk-free and liquid
- there is a large and active secondary market
44
What are the features of investing in government bonds?
- interest received on the due payment dates
- can liquidate their investment at any time by selling the bonds in the secondary market
- bonds are short-date when purchased, they can hold the bonds to maturity and have them redeemed at par
45
What are the risks of government bonds?
- price ricks:esp for longer-date bonds
| - if market interest rate increases/decrease , value will fall/rise
46
Which short-term investments are more likely to be purchased by investment institutions rather than by entities with a short-term cash surplus?
```
corporate bonds
commercial paper (CP)
```
47
What is a corporate bond?
- bonds issues by an entity
- long-term investments, high risk
- fluctuate with interest rates
- affected by perceived credit risk of issuer
48
What is a commercial paper (CP)?
- short-dated negotiable debt instruments
- issue by entity
- sold by bank managing entity's CP programme
- generally negotiable and purchased by large investment institutions and held to maturity
- not suitable for short-term investment of cash surpluses by a trading entity
49
What is working capital?
capital available for conducting the day-to-day operations of an organisation
-excess of current assets over current liabilities
50
What is working capital management?
all aspects of both current assets and current liabilities, to minimise the risk of insolvency while maximising the return on assets
51
What are the costs of investing in working capital?
- cost of funding it
| - opportunity cost of lost investment opportunities because cash is tied up and unavailable for other uses
52
What is the main objective of working capital management?
get the balance of current assets and current liabilities right: cash flow vs profits trade off
53
What are some consequences of poor working capital management?
- cant pay bills
- demands on cash during periods of growth being too great (overtrading)
- over-stocking or stock-outs
54
What is the trade off between cash flow and profit?
cash can help with low profit, profit can help with low liquidity
- purchase of NCA for cash
- sale of goods on credit
- timing of tax payment
55
What is the trade off between profitability and liquidity?
when an entity is able to improve its profitability but at the expense of tying up cash:
- receiving bulk purchase discount for buying unnecessary amount of inventory
- offering customers credit
- early settlement discount to customers
56
What are the main sources of liquidity?
- cash in the bank
- short-term investments that can be cashed in easily
- cash inflows from normal operations
- overdraft facility
57
What is the working capital cycle?
length of time between the entity's outlay on raw materials, wages and other expenditures and the inflow of cash from the sale of goods
-time span between incurring production costs and receiving cash returns
58
How is the working capital cycle calculated?
cash operating cycle = inventory days + trade receivable days - trade payable days =working capital cycle
59
If firms can 'push' items around cycle, what does this mean for the investment in working capital?
the lower the investment will be
60
How does the firm's investment in working capital gradually increase?
first only in raw materials
then in labour and overheads as production progresses
this investment must be maintained until TR
-can reduce investment by taking credit from suppliers
61
What factors affect the length of the cycle?
- liquidity vs profitability decisions
- management efficiency
- industry norms e.g retail vs construction
62
What is the optimum level of working capital?
amount that results in no idle cash or unused inventory but does not put a strain on liquid resources
63
How does the nature of a business affect the length of the working capital cycle?
- supermarket chain will have low or negative cycle as they have few credit customers, high inv turnover and can negotiate long credit periods with suppliers
- construction entity will have long cycle as their projects are and bulk of cash is received at the end of the project
64
If sales increase and the length of the cycle stays the same, what happens to the funds needed?
increase proportionate to activity
65
If length of cycle increases and sales stay the same, what happens to the funds needed?
increase proportionate to length of cycle
66
What are the factors that affect the amount required to invest in working capital?
- industry
- type of products sold:perishables, low inv
- whether products are manufactures or bought in: manu, high raw mat and WIP
- the level of sales:if high, high receivables
- policies towards working capital management:diff strategies
67
What should entities ensure they have during periods of uncertainty?
minimal level of cash and inventories based on expected revenue plus an additional safety buffer
68
What factors impact the working capital investment levels?
1. nature of business
2. uncertainty in supplier deliveries
3. overall level of activity of the business
4. entity's credit policy
5. length of the working capital cycle
6. credit policy of suppliers
69
What are the 3 possible working capital management policies?
aggressive, conservative, moderate
70
What is an aggressive working capital management policy?
reduce costs by holding low capital
- produces shorter operating cycle
- greater risk of illiquidity
- greatest returns
- short-term finance sourced
71
What is a conservative working capital management policy?
- reduce risk through higher levels of cash, inv and rec
- produces long operating cycle
- risk such as stock-outs or liquidity problems are low but costs are increased
72
What is a moderate capital management policy?
middle ground between aggressive and conservative approaches
73
What are the benefits of a more conservative approach?
- lower risk
- higher cost in terms of money tied up in working capital
- lower liquidity risk
- can meet changes in demand
- more relaxed credit policy
74
What was the traditional pattern of current assets?
fluctuating, originally with seasonal pattern
- financed out of short-term credit
- NCAs on long-term credit
- simplistic view
75
What are the risks to a borrower of short term finance?
renewal problems-continually renegotiated
| stability of interest rates-mercy of fluctuations
76
How does an aggressive policy finance variable and a portion of fixed working capital?
through short term finance
77
How does a conservative approach finance all permanent and current assets?
long-term financing
| -only use short-term financing for fluctuating current assets
78
What type of finance do moderate policies use?
- short-term finance for fluctuating current assets
| - long term finance for permanent current assets and on current assets
79
What does healthy trading growth lead to?
- increased profitability
| - need to increase investment in non-current assets and working capital
80
What is overtrading?
when a business does not have sufficient capital to fund the increase in profitability or investment
-resources surpassed by activity
81
What are some indicators of overtrading?
- rapid increase in turnover (revenue)
- rapid increase in the volume of current assets
- most of the increase in assets being financed by credit
- dramatic drop in liquidity ratios
82
What are some solutions to overtrading?
- raising more long-term capital, in the form of new shares or loans
- slowing down growth to reduce the increases in working cap requirements until sufficient cash has been built up to finance it
- improving working capital management so that there is a reduction in the inventory holding period or a reduction in the average time for customers to pay
83
What are the risks of overtrading?
possibility that the bank will withdraw its overdraft facility
84
What is the raw material inventory holding period?
the length of time raw materials are held between purchase and being used in production
=(average raw material / material usage ) x 365
NB can use purchases if material usage unavailable
85
How is raw material inventory holding period calculated?
=(average raw material inventory held/material usage) x 365
=(opening inv+closing inventory)/2x365/material usage
can use purchases is material usage is unavailable
86
What can be used instead of material usage in calculating raw material inventory holding period?
purchases
87
What is the WIP holding period?
length of time goods spend in production
88
How is WIP holding period calculated?
=average WIP x 365/production cost
89
When production cost cannot be calculated, what can be used instead to calculate WIP holding period?
cost of goods sold can be used
90
What is finished goods inventory holding period?
the is the length of time finished goods are held between purchase/completion and sale
91
How is finished goods inventory holding period calculated?
=average finished goods inventory held x 365 /costs of goods sold
92
What is inventory turnover?
how many rounds until finished goods is turns into sales
93
How is inventory turnover (no/ times) calculated?
cost of goods sold/average inventory held
94
How are inventory periods interpreted?
- high inv days means conservative policy or stock-piling for new launch
- if low inv, might show JIT concept or cash flow crisis and need for more aggressive working cap finance policy
- need to compare inv days to other companies
- inv levels are a balancing act
95
What are trade receivable days?
the length of time credit is extended to customers
96
How is TR days calculated?
avg receivables x 365 / credit sales
97
What does a shorter credit period mean?
financially prudent but also depends on nature of business
98
Is a shorter trade receivables period better?
yes, as receivables are effectively borrowing from the entity
-reflects ability of credit controllers and nature of business
99
What are trade payable days?
average period of credit extended by suppliers
100
How is trade payable days calculated?
=average payables x 365/credit purchases
101
Is it better to have a shorter or longer TP period?
longer as you are holding cash for longer
- need to make sure suppliers are not upset and no loss of goodwill
- suppliers may stop discounts or increase future prices
102
How can you calculate the turnover ratio?
invert ratio given and remove multiple
103
What are the limitations of ratios?
- SOFP values at the time may not be typical
- may not represent average e.g seasonal
- ratios subject to window dressing/manipulation
- historic
- maybe be distorted by inflation/rapid growth
104
What is selling on credit?
buy now, pay later
| -receivable created which sits as an asset in the SOFP of the entity
105
What is the issue with selling on credit?
businesses have to wait for their cash
106
What is a credit policy?
outlines business terms and conditions and internal procedures i.r.t offering credit to customers
107
Which two factors have to be balanced when deciding the optimum level of trade credit?
profit improvement from sales obtained by allowing credit
| cost of credit allowed
108
Why have a credit policy?
- credit terms are part of firm's marketing policy
- might be common practice
- lenient policy will attract customers but at a disproportionate increase in cost
109
What is the receivables balancing act?
tradeoff between:
- liquidity:collecting sales receipts quickly
- profitability:extending credit period to customers to encourage additional sales
110
For AR, what could influence an entity's credit policy?
- demand for products
- competitors' terms
- risk of irrecoverable debts
- financing costs
- costs of credit control
111
What are the 4 key aspects of receivables management?
1. Assessing creditworthiness of customers
2. Setting credit limits
3. Invoicing promptly and collecting overdue debts
4. Monitoring the credit system
112
When should a firm assess creditworthiness?
- new customers immediately
| - existing customers periodically
113
Where can you get information to assess creditworthiness?
- bank references
- trade references
- visit premises
- competitors
- published info
- credit reference agencies
- credit scoring
- legal sources of credit info e.g Individual Insolvency Register
114
What are the 2 limits that need to be set when setting credit limits?
- amount of credit available
| - length of time allowed before payment is due
115
Who qualifies for a higher credit limit?
a prompt payer/financially strong company
116
When does the credit period begin?
once invoice is received so prompt invoicing is essential
117
What is the procedure for following up debts?
1. Reminder letter
2. Telephone calls
3. Withholding supplies
4. Debt collectors
5. Legal action
118
What indicates a high chance of default?
- longer the debt runs
| - customer with financially weak firm
119
How can you motivate credit control staff?
- collection targets for team
- collection target for individual
requires performance assessment and reward
120
How can receivables be monitored?
- age analysis
- ratios
- statistical data
121
What does an aged analysis show?
- list of customers who owe money
- total amount owed
- period of time for which money has been owed
makes it easier to spot bad debtors
122
How can you calculate the finance cost of financing receivables?
finance cost=receivable balance x interest (overdraft) rate
123
How is receivable balance calculated?
receivable balance = sales x receivable days /365
124
What are early settlement discounts?
cash discounts given to encourage early payment by customers
- cost of discount balanced against savings made from having less capital tied up
- may reduce irrecoverable debts
125
What is factoring?
sale of debts to a third part at a discount in return for prompt cash
126
What services can an entity choose from a factor?
1. debt collection and administration -recourse/non-recourse
| 2. credit insurance
127
Which size of firms most from factoring services?
- smaller firms
- fast growing firms
help accelerate cash flow by advancing value of some debt
128
What does a factor's debt collection and administration entail?
takes over whole of the entity's sales ledger, issuing invoices and collecting debts
129
What does credit insurance entail?
agrees to insure the irrecoverable debts of the client by determining whom the entity was able to offer credit
130
What rate do factoring companies usually charge?
1.5-5% above bank base rate and interest is charged on a daily basis
131
What is factoring without recourse?
protection for client against irrecoverable debts
- factor bears loss and client received the money
- credit protection provided
132
What is factoring with recourse?
client bears loss from irrecoverable debt so must reimburse factor
- no credit protection provided
- more flexibility with granting credit
133
What are the advantages of using a debt factoring company?
- saving admin costs
- reduction in need for management control
- useful for small/fast growing businesses where the credit control team nay not be able to keep up
- improves cash flow
134
What are the disadvantages of factoring?
- more costly than an efficiently run credit control team
- factoring has a bad reputation, hints at financially weak firm
- customers may not wish to deal with a factor
- once you start factoring it is difficult to bring in-house
- company may give up opportunity to decide whom to give credit to (non-recourse factoring)
135
What is invoice discounting?
method of raising finance against the security of receivables without using the sales ledger administration services of a factor
-also provided by factoring companies
136
What is the difference between factoring and invoice discounting?
- invoice discounting is a confidential service
- financing part similar
- control of credit kept with entity
- control of sales ledger retained
137
How does invoice discounting work?
- business sends out invoices/collects debt
- invoice discounter provides cash to business for a portion of the value of the invoice and agrees to discount it, advances up to 80%
- when business collects payment, money is paid to invoice discounter who pays the business the remainder of the invoice less admin and interest
- discounter check's sales ledger of client every few months to make sure debt collection processes are adequate
138
How much is the admin charge for invoice discounting?
0. 5-1% of client's turnover
| - more risky since client retains control
139
How much are the finance costs of invoice discounting?
3-4% above base rate although larger entities may receive better terms
140
What is the payables balancing act?
trade off between
- liquidity:delaying payments to obtain 'free' finance
- profitability: delaying too long may cause long run issues
141
What problems can arise when payments are delayed too long?
- suppliers may refuse to supply in the future
- suppliers may only supply on cash basis
- there may be a loss of reputation
- suppliers may increase price in future
142
When is trade credit not 'free' source of finance?
when an discount for early payment may be available thereby meaning it is no longer free since the loss of discount is a cost
143
How can reducing working capital by holding on to creditor' money backfire?
in the long term, will affect supplier's willingness to supply goods and raw materials
144
What does the age analysis of payables show?
- total amount payable
- when money will be made payable
- amounts payable to each individual supplier and how close to credit limit sum is
- whether entity is failing to pay its trade suppliers on time
145
What is the inventory balancing act?
trade off between:
- profitability: reducing inv to lowest possible amount to minimise the level of capital employed (CE) to be funded
- liquidity:ensuring that sufficient inventory is held so that it does not run out and disrupt business
146
What are the costs of high inventory levels?
- foregone interest that is lost from tying up capital in inventory
- holding costs :storage, stores admin, risk of theft, insurance
147
What are the interest costs of inventory?
once goods are purchased, capital is tied up in them until sold on and capital earns no return
-this is an opportunity cost
148
What are the costs of low inventory levels?
- stockouts: lost contribution, production stoppages, emergency orders
- high re-order/setup costs
- lost quantity discounts
149
What is a stockout?
- running out of a product may cause disruption via idle time, stockpiling of WIP or missed orders
- running out of finished goods can result in dissatisfied customers
150
What is a lost quantity discount?
purchasing items in bulk will often attract a discount from a suppliers
with small amounts, harder to obtain discounts
151
What is the objective of good inventory management?
- optimum re-order level
- optimum re-order quantity
holding costs vs stock out/reorder costs
152
What is lead time?
lag between when an order is placed and the item is delivered
153
What is buffer inventory?
basic level of inventory kept for emergencies, required because both demand and lead time will fluctuate
154
What is the re-order level vs re-order quantity?
level: how many items left
quantity: how many should be ordered
155
What is EOQ?
Economic Order Quantity
| -number of units that a company should add to inventory with each order to minimise the total costs of inventory
156
What is the aim of EOQ?
minimise the total cost of holding and ordering inventory
157
What are the assumptions of the EOQ model?
- demand and lead time are constant and known
- purchase price is constant
- no buffer inventory held as it is assumed that it is not needed since demand and lead times are known with certainty
158
In EOQ, what must be balanced to minimise the total cost of holding and ordering inventory?
- variable costs of holding the inventory
| - fixed costs of placing the order
159
What type of relationship exists between the reorder quantity and total annual holding costs?
upward sloping linear relationship
160
What is the relationship between re-order quantity and annual cost?
downward sloping, curved relationship
161
At what point is total cost minimised?
where total holding costs = equals the total ordering costs = EOR
i.e where reorder quant minimises total cost of holding and ordering
162
How do you decide whether to stick to EOQ or increase order quantity to obtain discount?
1. Calculate EOQ
2. If EOQ< quantity, calculate the total annual inventory cost arising from using the EOQ
3. Recalculate total annual inventory costs using the order size required to just obtain each discount
4. Compare cost of steps 2 and 3 with the saving from the discount and select the minimum cost alternative
5. Repeat for all discount levels
163
What are the criticisms of EOQ?
- based on simplifying assumptions, such as constant and predictable material usage rates
- will not indicate the optimal purchase quantity when there are price discounts
- ignores problem of managing stock-outs
- inconsistent with the philosophy of JIT management and TQM
164
What is the periodic review system?
inventory levels reviews at fixed intervals
- inv at hand is made up to a predetermined level
- takes into account demand before next review and demand during lead time
165
What should management do with slow moving inventory?
- eliminate obsolete items
- only order when needed
- review demand level estimates on which re-order decisions are based
166
What is JIT systems?
manufacturing and supply chain techniques that aim to minimise inv levels and improve customer service by manufacturing not only at the exact time customers require but also in the exact quantities they need and at competitive prices
-elimination of all activities that do not add value
167
What are the aims of JIT?
- smooth flow of work through the manufacturing plant
- flexible production process which is responsive to the customers' requirements
- reduction in capital tied up in inventory
- eliminate waste at every stage of the manufacturing process
168
What does a JIT manufacturer seek in their supplier?
- high quality, frequent and reliable deliveries
- not just low price
- supplier can expect more business and rely on company through long term contracts
169
What costs are higher with JIT?
inventory ordering costs high
inventory holding costs are 0
170
What are the 3 main systems used to monitor and control inventory levels?
1. reorder level system
2. periodic review system
3. mixed systems, incorporating elements of both of the above
171
What is the two-bin system?
- now known as re-order level
- inv is kept in two bins :one with an amount equal to ROL quantity and the rest in other
- inv drawn from the latter until it runs out, which triggers reorder
172
Why is a ROL system hard to implement?
many variables are uncertain
| -average usage, supplier lead time etc
173
What is the constant cycle system?
- now known as periodic review system
- inv levels reviewed after a fixed interval
- replenishment orders issues where necessary
- order sizes variable
174
What is a mixed system?
-mix of both systems are sometimes used depending on the nature of the problem and the amount of computerisation and so on
175
What is the ROL when demand and lead time are known?
quantity on hand when an order is placed
| -ROL=demand in lead time
176
What is the ROL with variable demand and lead time?
ROL= maximum demand x maximum lead time
| -created buffer stock
177
When is buffer stock used?
- if actual demand during the supply lead time > average demand
- if lead times are longer than expected
178
What is the cost of buffer stock?
annual cost = amount of buffer x annual holding cost for one unit
179
How do you calculate buffer stock?
ROL- average usage
180
What does the optimum level of buffer stock depend on?
- variability of demand
- cost of holding inventory
- cost of stockouts
181
What are the two inventory warning levels?
when quantity is :
- higher than should be expected
- below the buffer stock level
182
What is the maximum inventory level?
- reorder level + reorder quantity - minimum demand per week x minimum RO lead time
- when new order has just been delivered
183
What is the minimum inventory level?
- buffer stock level
| - ROL - avg demand per period x avg RO lead time
184
Why do businesses need to keep a certain amount of cash readily available?
- transactions motive
- precautionary motive
- investment/speculative motive
185
What could failure to carry sufficient funds lead to?
- loss of settlement discounts
- loss of supplier goodwill
- poor industrial relations
- potential liquidation
186
What are the key principles of cash management?
- collect debts as quickly as possible
- pay suppliers as late as possible
- bank cash takings promptly
187
What is the cash balancing act?
profitability: minimising holding of cash, better invested
liquidity: ability to pay bills as they fall due and take advantage of opportunities at once
188
What is a cash forecast?
- aka cash budget
| - estimate of cash receipts and payments for a future period under existing conditions
189
What are cash forecasts used for?
- assess and integrate operating budgets
- plan for cash shortages and surpluses
- compare with actual spending
190
What are the two techniques that can be used to create a cash budget?
- receipts and payments forecast
| - statement of financial position forecast
191
What is the receipts and payments forecast?
- based on predictions of sales and cost of sales
| - timings of cash flows will need to be considered to produce a reasonable forecast
192
Why do cash receipts and payments differ from sales and cost of sales in SPL?
- not all cash receipts/payments affect SPL e.g issuing new shares
- some of SPL is derived from accounting conventions, not cash flows e.g depreciation
- timing of receipts/payments does not coincide with the SPL accounting period e.g sale made on credit
- irrecoverable debts will never be received in cash and doubtful debts may not be received
193
What is the receipts and forecast approach?
1. Prepare a pro-forma
- no set formula
- clear diff between payments and receipts per period
- net cash flow figure per period
2. Fill in the simple figures
- wages, fixed OH, dividend payments, purchases of NCA
3. Work out the more complex figures
- timings, variable OH, prod schedules, inv balances
194
What is the SOFP cash forecast?
- derived from predictions of future SOFP
| - all items except cash, which is then derived as a balancing figure
195
What forecasts does the SOFP cash forecast require?
- changed to NCA
- future inventory levels
- future receivables levels
- future payables levels
- changes to share capital and other long-term funding
- changes to retained profits
196
Why are spreadsheets useful in preparing a cash forecast?
- save time
- sensitivity analysis:easily change for diff outcomes based on diff assumptions
- can be consolidated:for diff entities on one overall forecast
197
Where can cash deficits arise from?
- basic trading factors underlying the business such as failing sales or increased costs
- short term deficiencies in working capital cycle eg long holding period for inventory
198
What solutions are there to short-term cash deficits?
- additional short-term borrowing
- negotiating a higher overdraft limit with the bank
- sale of short-term investments, if the entity has any
- using different forms of financing to reduce cash flows in the short term
- changing the amount of discretionary cash flows, deferring expenditures or bringing forward revenues
- bringing forward planned disposal of NCA
- reducing inv levels, using JIT
- shortening operating cycle by reducing receivables days
- shortening operating cycle by increasing payables days
199
What do cash surpluses indicate?
- depends on size and duration
- investment opportunities
- long term surpluses could be used to pay higher dividends or repay debts
200
What is the discount market?
active money market for bills of exchange (discount papers)
| -bought at discount as they don't give interest
201
What are some examples of discount papers?
resold for less than face value:
- bill of exchange
- treasury bills
202
What does a more conservative approach mean for risk and amount of money tied up in working capital?
lower risk
| higher cost tied up
203
How is working capital turnover calculated?
sales revenue/net working capital
