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Operational Case Study > F1 - Working Capital > Flashcards

F1 - Working Capital Flashcards

1
Q

What is working capital?

A

The cash invested in current assets less current liabilities

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2
Q

What makes up current assets?

A

Inventories, receivables and cash

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3
Q

What makes up current liabilities?

A

Payables, short term loans and overdrafts

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4
Q

What are the 2 priorities in managing working capital?

A
  1. Ensure there is sufficient cash to pay its liabilities

2. Ensure the organisation is as efficient as possible by ensuring all capital is invested to earn maximum profit

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5
Q

What are the permanent portion of current assets?

A

Certain base levels of inventory that are always carried, and the cash balances that never fall below a certain level

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6
Q

What are the fluctuating portion of current assets?

A

The proportion of the current assets that are not fixed e.g. due to seasonality

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7
Q

What is a conservative approach to funding working capital?

A

Where ALL non current, ALL permanent current and PART of the fluctuating current assets are financed out of long term funds

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8
Q

What are the benefit and downside of a conservative approach to funding working capital?

A

Low risk vs low return (long term finance expensive)

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9
Q

What is an aggressive approach to funding working capital?

A

ONLY the non current assets are financed by long term finance

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10
Q

What are the benefit and downside of an aggressive approach to funding working capital?

A

High returns vs high risk (short term interest may not be renewed or interest rates may rise)

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11
Q

What is a moderate / matching approach to funding working capital?

A

Non current and permanent current assets are funded by long term finance, fluctuating current assets are funded by short term finance

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12
Q

What is over capitalization and when does it occur?

A

Having too much cash tied up in the business (too high inventory, receivables and cash balances), which could be used elsewhere

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13
Q

What is overtrading?

A

When the business does too much too quickly and has too little working capital, so cannot pay its debts when they fall due

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14
Q

When is overtrading most common?

A

In expanding young businesses with insufficient sources of long term finance

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15
Q

What are 2 typical signs of overtrading?

A
  1. Rapid increase in revenue and current assets financed by credit
  2. Significant decrease in liquidity ratios
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16
Q

What are 3 solutions to overtrading?

A
  1. Issuing shares
  2. Slowing down growth of the business
  3. Managing working capital better e.g. offering settlement discounts
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17
Q

How do you calculate the working capital cycle?

A

Inventory Days + Receivables Days - Trade Payables

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18
Q

What does the working capital cycle show?

A

The length of time between payment of cash for goods and receipt of cash from their sale - number of days that financing is needed for

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19
Q

What are 3 key actions that can be taken to reduce the working capital cycle? (and their issues)

A
  1. Delay paying trade payables (relationships)
  2. Reduce time allowed to customers to pay (relationships)
  3. Reduce inventory levels (stock out issues)
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20
Q

What is the calculation for receivables days?

A

Receivables / credit sales x 365

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21
Q

What is the calculation for inventory days?

A

Inventory / COS x 365

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22
Q

What is the calculation for payables days?

A

Inventory / Credit purchases (or COS) x 365

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23
Q

What is the calculation for the current ((acid test)) ratio?

A

Current assets ((minus inventories)) / current liabilities

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24
Q

What are the 3 motives for holding cash?

A
  1. Everyday transactions
  2. Precautionary needs
  3. Speculative future opportunities
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25
Q

What is a cash budget?

A

Detailed budget of estimated cash inflows and outflows incorporating both revenue and capital items

26
Q

What is the main use of a cash budget?

A

To identify future moments of cash surplus or shortage

27
Q

What are the 4 key methods of accessing short term finance when there is to be a shortage of cash?

A
  1. Bank overdraft
  2. Short term loans
  3. Debt factoring
  4. Trade payables
28
Q

What are the 2 main benefits of an overdraft facility?

A
  1. Flexible

2. Interest only paid on what is used

29
Q

What are the 2 main disadvantages of an overdraft facility?

A
  1. Repayable on demand

2. High interest rates

30
Q

What is the main benefit of a short term loan?

A

Lower risk

31
Q

What is the main disadvantage of a short term loan?

A

Less flexible

32
Q

What are the 5 investment criteria to be considered when investing short term cash surpluses?

A
  1. Maturity
  2. Risk
  3. Return
  4. Liquidity
  5. Diversification
33
Q

What are the 2 main trade offs in investing critera?

A

Risk vs Return

Return vs Liquidity

34
Q

What are the 4 main options of cash investment?

A
  1. Bank accounts
  2. Treasury Bills (short term)
  3. Shares in other companies (long term)
  4. Certificates of deposit (medium term)
35
Q

What are 3 additional options of covering short term cash shortages for companies who trade internationally?

A
  1. Bills of Exchange (IOUs)
  2. Forfaiting (sell bill of exchange to third party)
  3. Export factoring
36
Q

What are the 2 conditions of credit offered to customers?

A
  1. Length of credit terms

2. Monetary limit on total amount

37
Q

Why would a company offer credit?

A

To increase total value of sales and profitability

38
Q

What 3 key things might influence a company’s credit policy?

A
  1. Costs of financing additional working capital
  2. Administration costs of operating credit control
  3. Additional sales generated versus additional bad debt
39
Q

What are 2 negatives of offering credit?

A
  1. Delay in receiving cash

2. Risk of bad debt

40
Q

What 3 things might you review for a new credit customer before offering credit?

A
  1. Trade reference
  2. Credit rating agency report
  3. Financial statements
41
Q

What is the calculation for cost of offering discounts?

A

( Original value / new value ) ^ 365/early days - 1

42
Q

What are the steps of debt factoring?

A
  1. Sell goods to customers on credit
  2. Sells receivables to factoring company
  3. Factoring company advances 80%
  4. Customer pays the factor
  5. Factor passes on balance minus fee
43
Q

What are the 2 main benefits of debt factoring?

A
  1. Pass on the risk of bad debt and administration

2. Get cash sooner

44
Q

What are the 2 main disadvantage of debt factoring?

A
  1. Damage relationship with customers as the factorer collects the debt
  2. May perceive the company to be in financial trouble
45
Q

What are the steps of invoice discounting?

A
  1. Sell goods to customer on credit
  2. Borrow % of receivables from invoice discounter
  3. Customer pays the business
  4. Business repays the borrowing plus interest and fees
46
Q

What are the 2 main benefits of invoice discounting?

A
  1. Get cash sooner

2. Confidential so no damage to reputation

47
Q

What are the 2 main disadvantages of invoice discounting?

A
  1. Maintain the risk of bad debts

2. Might not accept some as they are perceived as too risky

48
Q

What are 3 main reasons for high receivables?

A
  1. Poor credit control
  2. High recent sales
  3. Long credit terms offered to attract customers
49
Q

What is the trade of for high payables?

A

Reduce cash operating cycle (better liquidity) vs damaging relationship with suppliers

50
Q

What are the 3 main benefits of having a central purchasing function?

A
  1. Access to bulk buying discounts, reducing cost per unit
  2. Easier to enforce common quality standards
  3. More efficient management of inventories, reducing the need to buy more quantities
51
Q

What are the 3 main disadvantages of having a central purchasing function?

A
  1. Specific requirements of departments may not be met
  2. Centralized standard procedure may results in delays in receiving materials
  3. Adverse effect on morale due to loss of central control
52
Q

What are 3 main reasons for high payables?

A
  1. High demand levels leading to high purchases
  2. Cash shortages
  3. Long credit periods offered by suppliers
53
Q

What are the 3 main benefits of holding inventory?

A
  1. Obtain bulk discounts
  2. Avoid stock outs
  3. Uncertain demand resulting in the need for buffer inventory
54
Q

What are the 3 categories of costs incurred in purchasing inventories?

A
  1. Purchase costs
  2. Order costs (admin, postage, quality)
  3. Holding costs (storage, insurance, opportunity costs)
55
Q

What are the 2 main disadvantages of holding inventory?

A
  1. Tying up cash that could be better used

2. Risk of obsolescence

56
Q

What is the economic order quantity model?

A

The EOQ model finds the order quantity that minimises total stock costs

57
Q

What are the 3 assumptions in the EOQ model?

A
  1. Constant, certain demand
  2. Instantaneous delivery
  3. Constant purchase costs (no discounts)
58
Q

What is the re order level system?

A

Inventory is reordered when it falls to a minimum level

59
Q

If demand and lead time are certain, what is the reorder level?

A

Demand expected in the lead time

60
Q

If demand and lead time are uncertain, what is the reorder level?

A

maximum demand x maximum lead time

61
Q

What is the buffer inventory level if demand is uncertain, using the re order level model?

A

Buffer inventory = re order level - average usage

62
Q

What is the aim of the JIT inventory model?

A

To minimise inventory levels by purchasing inventory just before they are required

Operational Case Study (10 decks)

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