F: Working Capital Flashcards
What is invoice factoring?
• sell debts to factor
• the collect debt for fee
• 80% advance, remaining once payment collected
• With/without recourse: with means burden of irrec on AB
Damage relations
Damage reputation
What is invoice discounting?
- Similar to factoring but control remains with AB
- Confidential: maintain relationships and relations
- 80% advance
- More flexible with large invoices rather than widespread credit control approach
What is JIT’s aim?
- Minimise inventory levels
* Improve customer service by timing and quantities at competitive prices
What are JIT’s assumptions?
- Hold very little stock: buy when required
- Reduce waste
- As few as possible suppliers: high quality, frequent, reliable, AB has close relationship
- More flexible prices: adapt to constraints, work flow
- Reduced capital tied up: currently 72 days
What is EOQ’s aim?
Optimum order quantity
Minimises total cost of holding and ordering inventory
Satisfy demand
What are the assumptions?
Demand is constant and known: variation? Seasonality?
Lead times are constant and known: some existing suppliers, some new
Purchase price constant: unknown, unrealistic
No buffer stock held: we hold to avoid stockouts
What are the main types of short-term finance?
- TP
- factoring or invoice discounting of TR
- bank overdrafts and short-term loans
- financing exports
What are the benefits of bank overdrafts as short-term cash requirement?
- flexible
- only pay for what is used, so generally cheaper
What are bank loans?
- contractual agreement for a specific fund, period and interest rate
- less flexible than overdraft
- provide greater security than overdraft
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
What are the two types of interest bearing accounts?
- bank deposit accounts
- money market deposits
What is a bank deposit account?
- some are instant access, highly liquid
- some allow withdrawal without notice
- some require notice period before withdrawal
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- cant be withdrawn until deposit matures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
What are some examples of negotiable instruments?
bank notes bearer bonds Certificates of Deposit bills of exchange treasury bills
What are the most negotiable instruments as short-term investments
Certificates of Deposit
Treasury bills
bills of exchange
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
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
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
How is the working capital cycle calculated?
cash operating cycle = inventory days + trade receivable days - trade payable days =working capital cycle
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
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
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
What is overtrading?
when a business does not have sufficient capital to fund the increase in profitability or investment
-resources surpassed by activity
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
