Finance - Working capital management Flashcards
What do working capital measures
- Working capital measures short-term liquidity:
Asset - liabilities - Entity should work to maximize its internal sources of cash before pursuing external financing
What is included in working capital
Wokring capital consist of A/R, A/P and inventory
Considerable decision - amount of cash to keep on hand, credit to the extent to the customer, level of inventory carried
What are the three main factors that are to be considered for cash management. What is minimum cash balance
- Expected - daily cash needed
- Uncertainty - about daily cash flows
- Cost - acquiring new cash on hand
Minimum cash balance - the minimum cash balance for a firm to hold normal operating circumstances
Explain what is cash conversion cycle
Cash conversion cycle - indicates how long the company must wait to receive cash on sales. From paying obligation *important analysis
Speculative motive - reflect the desire to take advantage of bargain opportunities
Transaction motive - Reflect the desire to have cash on hand to pay specific bills, or the result of non-voluntary holding of cash
Compensating motive - need to comply with loan requirement that stipulate a compensating balance
What are some factors to reduce the need for a large cash balance and investing in excess cash
- Entity is able to borrow.
- Entity size
- Cost of holding cash
- Need to know how long will cash be invested and when investing mature can the entity afford to lose an initial investment. How quickly cash cash be acquired
What factors are need to be considered for investing
Maturity - The maturity date is set at the time of purchase, Have no maturity date
Preservation of capital - Principal is return at maturity, No guarantee that capital will be preserved
Liquidity - Ability to access the cash needed. Invested in fixed-income security. Cash is locked in until maturity, Penalty is payable if the investment is redeemed.
Income type - Interest income and capital gain/losses if sold
Level of risk - Low risk if held to maturity, Higher risk cash value equals fair value at the time of sale
What are the 4 securities to invest in
Guaranteed Investment certificate - Canadian term deposit, purchase from banks trust companies, credit
Treasury bills - Issued by the Govn’t of Canada, higher risk, low risk (30-270 days)
Banker acceptance - Short-term debt. Instrument issued by a corporation. 1-3 month period 50,000 - 500,000
Commercial paper - Short-term promissory not missed by corporation with good credit, minimum 100,000 investment can be sold quickly
How can A/R be shorted of the life cycle
- Shortening the credit period extended to the customer
- Implementing discount for early payment
- Monitoring customer accounts to ensure that customers pay on time
What determines the credit period for customers to pay back credit
Nature of product sold - The shorter the credit period will be on its sale. Slower moving product or new product
Customer demand - The higher the demand for a product is, the shorter the credit period will on its sale
Credit risk - The higher the credit risk of the customer, the shorter the length of the credit period
Competition - The company operates in a very competitive industry, longer credit periods will be extended
What are the five factors management should consider? Five C’s
Characteristics - Customer willingness to pay on time
Capacity - Customer ability to pay on time, from its operating cash flow
Capital - Customer capital source, including equity supporting its ability
Collateral - Nature of asset the customer could pledge as security
Condition - Current general or specific economic condition that could affect the customer’s ability to pay on time
What measuring tool is used for A/R management
A/R turnover - Net credit sales / A/R Average Average collection period - By sales in receivable
(Average A/R balance / sales) *365
What are the 5 components of inventory management to hold
- Cost of restocking the inventory (ordering cost)
- Rate of demand for products
- Carry cost
- Degree of uncertainty wish future demand for the product
- Obsolescence of product
Provide the three cost of carrying inventory
- Order cost - Cost associated with placing each inventory order, shipping transportation
- Carrying cost - The opportunity cost of funding up in inventory plus the cost of physically holding inventory
- Stock cost - These are the costs that come from running out of product. Can lose sales as well as customer loyalty, production processes may be disrupted
What are the types of methods for optimal volume of inventory
- Just in Time (JIT) - minimizes carrying cost
- Economic order quantity model (EOQ) - optimal inventory to be held and when to be reordered
- Allows for delivery lead time - Consignment - Inventory is shipped to the buyer but the seller retain ownership
Inventory turnover - COGS / Average inventory
Days sales in inventory - (Average inventory/ COGS)*365
Explain how accounts payable management is used for working capital
Accomplish delaying cash disbursement & negotiated extended credit terms, taking advantage of discounts offered by suppliers for early payment
- The risk is paying late interest. Hurts supplier relationship, negatively impact credit rating
Suppliers can provide cash discounts of credit term
- 3/15 net 35, 3% pay within 15 days if not full amount at 35 days
* use of effective annual interest rate =
(1+ Cash discount / (price- cash discount) ^(365/extra days_ - 1
