FM - Working Capital Flashcards
Net working capital
Net working capital is computed as current assets minus current liabilities.
Accounts receivable.
Inventory.
Accounts Payable.
The main reason to retain working capital is to meet the firm’s financial obligations. Therefore, the amount is determined by offsetting the benefit of current assets and current liabilities against the probability of technical insolvency.
A firm may be either over invested or under invested in net working capital. If over invested in net working capital, typically it will earn a lower return than would be possible if the assets were invested in capital projects. If under invested in net working capital, a firm maybe unable to meet current operating and financial needs, including having inadequate cash, and incurring inventory shortages.
drafts
Payments made with drafts are guaranteed by the entity on which the draft is drawn.
-A working capital technique that increases the payable float and therefore delays the outflow of cash
A “payment through” draft is a check-like instrument that can be distinguished from a check by the fact that it contains the words “payable through” followed by the name of the bank through which payment will be made. When present to the bank for payment, these drafts do not immediately draw funds from the account of the issuer of the draft (the payer), but rather the bank through which the draft is drawn must present the draft to the issuer for approval. If the issuer approves the draft it returns it to the bank so that payment can be made to the payee. As a result of the clearing process, the issuer:
has use of its funds for a longer period of time than when using a check, and
the issuer has more control over final disbursements.
Pre‐authorized checks
Pre‐authorized checks can be used to reduce float on customer payments.
Pre‐authorized checks focus on cash receipts, not cash disbursements. In a pre‐authorized check arrangement, customers preauthorize a firm to draw checks on the customer’s checking (or other demand deposit) account. On a prescribed date, preauthorized checks are prepared and processed by the firm, and the amounts deposited directly to the firm’s bank account.
Remote disbursing
Remote disbursing is a practice intended to increase the payment float on checks used to pay obligations.
Concentration banking
Concentration banking can be used to facilitate the investment of excess cash.
Depository transfer checks
Depository transfer checks are used to accelerate transfer of a firm’s cash between its accounts at different financial institutions.
-can be used in conjunction with a concentration banking arrangement.
Remote disbursing
Remote disbursing involves paying bills with checks drawn on accounts with banks in remote locations.
cash management
The general objective of cash management is to maintain a cash balance between holding too little cash and holding too much cash.
A firm must maintain adequate cash on an on‐going basis to meet its cash‐requiring obligations that arise in the normal course of its business activities‐‐accounts payable, salaries and wages, etc.
On the other hand, holding too much cash (excess cash over that needed for immediate obligations) is an inefficient use of resources, since the return on unneeded cash usually is less than could be earned if the cash were invested in assets with a higher return (e.g., securities, inventory, capital projects, etc.).
Float
Float is the length of time between the writing of a check (or other draft instrument) and the actual transfer of the funds.
Receipt float is the time between the writing of a check (or other instrument) by a customer and when those funds become available to the party to which the check was made.
Disbursement float is the time between the writing of a check by a firm writes and removal of the funds from the firm’s account.
Efficient cash management will seek to decrease receipt float and increase disbursement float.
By reducing receipt float, a firm has cash it is receiving available sooner than it would be available otherwise.
By increasing disbursement float, a firm has cash it is paying available longer than it otherwise would be available. Thus, decreasing receipt float and increasing disbursement float make more cash available to a firm.
Zero‐balance account.
A zero‐balance account is a cash management technique that permits control over cash outflows by using a checking account that has a zero ($0) real balance because payments made from the account exactly equal deposits to the account. From a financial management perspective, a zero‐balance account arrangement enables decentralized units to write checks drawn on one of that unit’s accounts that has no real balance.
Repurchase agreements
Repurchase agreements can be used as investment instruments for as short a period as one day.
A repurchase agreement investment provides for the seller to repurchase the instrument with no loss in value.
Are usually for large amounts
Bankers’ acceptances
Bankers’ acceptances are drafts that are frequently used in financing of foreign transactions.
Because acceptances have a higher risk and less marketability than Treasury or Federal agency obligations, they have a higher yield than those securities.
Commercial paper
Commercial paper is a form of short‐term unsecured promissory note.
-can be issued only by large firms with high credit ratings.
Because of the lack of marketability, commercial paper provides a yield greater than other short-term instruments with comparable risk, but usually still less than the prime rate of interest.
U.S. Treasury Bills
U.S. Treasury Bills are a highly desirable form of temporary investment.
Offer safety of principal, marketability, and if held short maturity - price stability.
short‐term investments is likely to provide the greatest safety of principal
federal agencies
Securities issued by federal agencies have higher yields than U.S. Treasury Bills due to slightly higher risk.
