Financial_Management 3

Question 1

What are the characteristics of effective Working Capital Management?

Answer 1

Shorten the cash conversion cycle Don’t negatively impact operations

Question 2

What traits should Cash and Short-Term Investments have?

Answer 2

Liquid Safe

Question 3

What is the Inventory Conversion Period?

Answer 3

Average time needed to convert materials into finished goods and sell them Average Inventory =(BI + E) / 2

Inventory Conversion Period =Average Inventory / Sales Per Day

Question 4

What is the Receivables Collection Period?

Answer 4

Average time needed to collect A/R RCP : Average Receivables / Credit Sales Per Day

Question 5

What is the Payables Deferral Period?

Answer 5

Average time between materials and labor purchase and their A/P payment Average Payables : (BP + EP) / 2 Payables Deferral Period : Average Payables / (COGS/365)

Question 6

What is a Lockbox System? What are the advantages?

Answer 6

Customer Payments are sent to a bank-managed PO box. Employees don’t have access to cash. Deposits are more timely. Interest income from deposits should pay for the Lockbox fees (if they don’t- lockbox is not beneficial)

Question 7

What is float?

Answer 7

Time it takes to mail a payment and have it clear your bank account Maximize float on cash payments Minimize float on cash receipts

Question 8

What is commercial paper?

Answer 8

Similar to T-Bill- but issued by corporations instead of Government Greater than 9 Months Maturity Unsecured Issued by large firms

Question 9

What are the advantages and disadvantages of Commercial Paper?

Answer 9

Advantages: Financing at less than Prime. No compensating balances required. Disadvantages: Unpredictability of markets. Credit crisis emerges and large insurance/investment companies aren’t lending.

Question 10

What is Order Cost?

Answer 10

Cost of executing an order and starting product production.

Question 11

What is a Just In Time (JIT) system?

Answer 11

Orders inventory so that you get it just in time for when it’s needed JIT is valuable when Order Cost is low and Cost of Carrying Inventory is high

Question 12

What is Factoring of receivables?

Answer 12

Receivables are sold to a financing company where they pay less than the value of the receivables due to a discount related to risk of non-collection

Question 13

What is a Trade Discount?

Answer 13

Buyer saves if paid early Example: 1/10 Net 30 1% Discount if paid within 10 days If not- bill is still due in 30 days

Question 14

What is the cost of forgoing a discount?

Answer 14

(Discount % x 365) / ((100% - Discount) x (Pay Period - Discount Period))

Question 15

What is the Prime Rate?

Answer 15

A benchmark used for lending only to the best customers Most customers will be charged Prime + 3%- for example If the lending institution and the customer are not in the same country- the LIBOR rate is often used

Question 16

What is the disadvantage of Common Stock in comparison to bonds?

Answer 16

Common Stock is more expensive to issue than debt. Why? Investors demand a greater ROI than debtors (bondholders)

Question 17

What is a Sinking Fund?

Answer 17

Borrower deposits regular sums into an account that will eventually pay off the debt

Question 18

What is CAPM?

Answer 18

A stock’s expected performance is based on its beta (risk) compared to that of the stock market. More risk : more expected return.

Question 19

What is the Cash Conversion Cycle?

Answer 19

Amount of time it takes to receive a cash inflow (Customers) after making a cash outflow (Vendors) Inventory Conversion Period + Receivables Collection Period - Payables Deferral Period : Cash Conversion Cycle (Inventory Really (-Pays) Cash)

Question 20

Debt Ratio

Answer 20

Total Debt to Total Assets = Total Debt / Total Assets

The Debt to Total Assets Ratio indicates the extent that leverage has been used to finance the assets held and the degree to which creditor protection is provided in the case of insolvency. It is also called the Debt Ratio.

A higher ratio indicates:

1. more leverage has been used. 2. there is a greater risk to the creditor. 3. there is a greater risk that the firm would not be able to meet its long-term obligations under adverse conditions.

Question 21

What is the advantage of using Trade Credit?

Answer 21

No interest cost if paid timely.

Question 22

Debt to equity

Answer 22

Debt to equity is total debt divided by total stockholders’ equity

The Debt to Equity Ratio measures the company’s ability to meet long-term obligations.

Question 23

Reasons to Hold Cash

Answer 23

There are four primary reasons for a company to hold cash.

a. Transactions purposes: Cash is necessary for a company to conduct its day-to-day business.
b. Precaution purposes: Since cash flows do not flow evenly over time and often cash inflows are not matched with cash outflows (a business cycle consideration), it is necessary to have enough cash on hand to compensate for unanticipated fluctuations in cash flows.

1. Precautionary cash is often held in highly liquid marketable securities. This provides security and additional interest income.
2. Today, most companies have a line-of-credit arrangement to cover the precautionary needs.

c. Speculative purposes: Cash balances are also necessary to allow a firm to take advantage of potential business opportunities such as bargain purchases.

1. Near-Cash is advisable for speculative purposes so that additional interest/dividend income can be earned.
2. Organizations often do not hold cash for speculative purposes if they have a readily available source of funds such as a line-of-credit.

d. To meet compensating balance requirements: Compensating balances are amounts required to be kept in an account by a bank and are often mandatory in order to obtain a loan or to avoid paying fees for individual bank services.

Question 24

The accounts receivable turnover ratio

Answer 24

he accounts receivable turnover ratio measures how quickly these receivables are collected. The quicker that they are collected, the less financing that is needed to support receivables.

Computation: Net credit sales ÷ Average AR

Limitations on use of this ratio: It should be computed on credit sales only

Question 25

Times Interest Earned

Answer 25

a. The Times Interest Earned Ratio measures a firm’s ability to cover interest charges. This is important since, at minimum, a company would need to pay current interest charges in a given period. This is also known as the Interest Coverage Ratio.
` Net Income Before Tax + Interest ExpenseTimes Interest Earned = ———————————– Interest Expense`

b. A higher ratio is associated with greater solvency and demonstrates a greater margin of safety for meeting fixed interest payments.
c. This ratio measures the ability to add new debt in the future.

Question 26

What are Zero Balance Accounts?

Answer 26

• A zero-balance account is one that maintains a zero-balance since funds only sufficient to cover the checks presented are transferred from another account.
• Regional bank sends enough cash to cover daily checks
• Advantages:
  
  • Checks take longer to clear -more float
  • Low amounts of cash tied up for compensating (minimum) balances

Question 27

What is Carrying Cost?

Answer 27

The cost of keeping inventory.

Inventory carrying costs are those costs incurred as a result of holding inventory for a period of time. All of the following are considered carrying costs:

• Storage
• Insurance
• Opportunity cost of inventory investment (i.e., the lost return that could have been earned by investing the cash used to purchase the inventory in some other way

Accounts receivable are at the optimal level when Carrying costs = Opportunity costs.

Question 28

What is inventory reorder point?

Answer 28

How low inventory should get before it should be re-ordered. IOP : Average Daily Demand x Average Lead Time