Midterm #2 Flashcards
cash conversion cycle
- time between when cash is received versus paid.
- The shorter the cash conversion period, the more efficient the firm’s working capital.
what is trade credit and what does it do?
def- spontaneously generated financing arising from the buyer’s daily operating activities
- provides liquidity
- avoid Payables Stretching: leads to nonpecuniary costs
what is
(1) Open Account
(2) Net Terms
(3) Cash discount
Open Account: without re-applying for credit each time, buyer purchases can be repeated and receive supplier financing
Net Terms: specifies the length of time the buyer has until payment
Cash discount: cash discount offered for earlier payment
Basic aspects of trade credit as a source of financing
Trade credit decouples
• Timing of acquisition of goods
• Associated payment
-Buyer’s earnings are immediately reduced by CGS value irrespective of PMT C/F
Balance fraction to monitor payment timing
- Shows the proportion of each month’s purchases that remain outstanding in the form of payables at month end
- Higher values of payables balance fractions indicate a longer delay in payment to suppliers
liquidity flow
-cash collections, the movement of cash within corporate demand deposit accounts and cash
disbursements
*ensure liquidity by optimizing amount and timing of liquidity flows
1) Cash collection
2) Concentration
3) Cash Disbursement
1) Cash collection- converting payments received from customers into collected balances as quickly as possible
2) Concentration- moving funds to a centralized depository account held at the lead bank
3) Cash Disbursement- settling financial obligations
Payment and collection systems
A firm’s perspective on float depends on
1) collections vs disbursements
2) A firm is motivated to expedite collections float and slow disbursement float
cash collections
- Shortening the time needed to collect on sales
- Shortens the days’ receivables of CCC
- Increasing operating C/Fs
- Improves firm liquidity
- no matter the terms of sales, cash collection efficiency improves firm liquidity
Optimal cash collection process depends on
1) industry affiliation (retail vs manufacturing)
2) customer type (business customer vs individual)
3) nature of the seller- customer relationship
When selecting a cash conversion system consider-
- Payment processing costs
- Speed of collection
- Security of collection
- Remittance information capability
check collections in cash conversion system
Checks provide the least efficient process of cash collection
• Declining checks usage
•Still used to transfer substantial sums of value
Collection float
the time interval between when the payor mails a check and the date on which the check is collected, and the payee has available funds
- payee seeks to min each component of the collection float
- eliminating float is impossible but managing is critical
company processing center
has staff members dedicated to depositing and processing checks
-Centralized and decentralized
- Depends on the volume and dollar amount of checks
processed
Which calculate the total cost of cash collection system
1) Opp. cost of collection float
2) Fixed Cost
3) Variable cost
1) Opp. cost of collection float: across centralized and decentralized
(as no collection system will eliminate the opp. Cost)
2) Fixed Cost: like clerical salaries, account maintenance fees, fees for transferring balances
2) Variable cost: per check, charges for processing, encoding, depositing, and paying employee wages
lockbox collection system
- Minimize each component of collection float by using specialized staff and state-of-the art equipment
- Combination of centralized and decentralized, where an external party handles processing
2 types of lockboxes
1) retail lockbox system- standardized remittance info (large value of checks and low dolla value)
2) wholesale lockbox system- B2B check PTMS ( lo value and large value) min opp cost of collection float
lockbox strategy
managers must determine the optimal
1) number of lockboxes
2) geographical placement of the lockboxes
3) allocation of customers among the chosen lockbox location
complete enumeration method
to determine the optimal number of lockbox banks and optimal allocation of customers among the boxes
optimizing the number of lockboxes
- development of a lockbox optimization model and the use of the complete enumeration method to optimize:
1) how many lockbox site locations
2) allocation of customer to lockbox site - determines the number of lockboxes and min total cost, and allocates customers to relative lockboxes
cash concentration system
internal transfer of funds from regional bank accounts to a centralized account controlled by the firm’s treasury department
how to concentrate funds?
1) physical pooling- funds are actually moved from the depositing accounts at regional banks to an account at the concentrating bank
2) notional pooling- balancing entries made on virtual bank account- allows for earning credit allowance or interest earned.
physical pooling to concentrate
methods 2
1) ACH- cost effective and efficient (settles in 1 day)
2) wire transfers- real time transfer of funds (expensive), optimal for concentrating large balances
Instruments (4)
1) multiple drawee check- specialized check that lists more than one bank on its face
2) controlled disbursement account- checking account for which banks provide early morning presentment info
3) zero balance acct (ZBA)- disbursment account that maintains a balance of $0. Centralized account provides funds equivalent to daily payments
4) Comprehensive payables- outsourcing most or all of the disbursements function to a bank
tools to fight check fraud
1) account reconciliation services- involve the firm providing the bank with a record of checks drawn on a depository account
2) paid only reconciliation- reports the check numbers, dollar amounts, and dates paid for all paid checks
3) full reconciliation- provides detailed info on checks outstanding and paid
4) positive pay- a daily check issue file is sent to the disbursing bank
5) reverse positive pay- the disbursement bank sends the check presentment file to the firm to determine whether the items should be honored
6) internal controls- ex) special check stock
Two models
- 2 models to quantify the financial impacts of changes to disbursement policies
• 1) Framework for evaluating a wholesale change in disbursement policies from check to ACH
• 2) Model to evaluate whether a firm should pay on individual financial obligation with check or ACH
• Use PV to determine the disbursement strategy that maximizes firm value.
Objective cash flow forecasting
1) ensure firm liquidity as C/F are unsynchronized and value maximization
- project future profitability
C/F forecasting
better forecast lead to (5)
1) timely payments and better relationships
2) higher credit rating
3) lower commitment fees for credit lines
4) improved control due to lower cash balances
5) reduced opp cost
Developing effective and efficient C/F forecasting
1) develop forecast philosophy
2) forecasting horizons (daily, lt forecast)
Cash budget technique
used to forecast C/F daily or intermediate
- determines if firm has cash surplus or deficit by comparing inflows and outflows with the current cash position
- links operating transactions to liquidity policy
target cash balance
balance requirement by the firms lead financial institution
descriptive statistics
- provides liquidity management; describe the location and variability for given distribution
- point of estimates based on sample net C/F
- categories-location, variability, miscellaneous
- point of estimates are biased but depends on sampling error
- sample mean can be very off
measures of location category provide
probable values for future net cash flows ex) mean, median and mode
measures of variability provide
dispersion or spread in the distribution. increased dispersion implies less predictability and more volatility ex) range, variance and std
variance* larger sample variance increased variability and less predictability
std* larger std more variability and less predictability
standard error
concern that the sample size does not approximate the population. a smaller standard error means the sample means are more closely approximate the population mean
miscellaneous category
sample observation with the smaller numerical value ex) max, min, sum, count
kurtosis
skewness
1) user to determine whether the distribution has a fatter tails compared to normal
2) distribution symmetry
descriptive statistics
point estimates are biased but depends on the degree of sampling error
-sample mean can be off therefore rely on confidence intervals
confidence intervals
reduces the effects of sampling error by providing a band of values that may contain population mean
*refers to distribution of potential population mean
time series methods
rely on data points over adjacent time periods to make inferences
- no needs to make assumptions on the variable distribution and large sample sizes
methods used moving avg and exponential smoothing
moving avg
uses an averaging process over a rolling time period
-emphasis on most recent cash flows
mean absolute deviation (mad) technique
used to assess the accruracy of time series forecasts
-represents the avg absolute deviation expected from given forecast
exponential smoothing
weighted average of the actual net cash flow and the forecast from the prior period
regression analysis
net cash flow based on the statistical relation between net cash flow and sales
-straightforward forecast for net cash flows
the opportunity cost of holding cash
benefits foregone by retaining cash instead of being used in other ways
agency cost of cash
costs that are borne by S/Hs when managers extract private benefits from corporate assets
-manager maximizes his own utility and benefits from perks
-cash holdings allow managers for increased spending with less monitoring from capital markets
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Characteristics of the money market
1) mature one year or less
2) low relative risk and have active secondary market
3) financial liability to the issuer and asset to investor
4) issued by banks, corporations and local gov
ex) bills and repurchase agreements
Money Market instrustment characterisitics
Wholesale market
Primary market
Secondary market
1) large dollar transactions
2) newly issued money market securities
3) instrument are bought and sold prior to maturity
Money Market instrument characteristics
Broad
Deep
Resiliency
broad- large number of investors
deep- large quantity of securities transacted
resiliency- push back prices to equilibrium with many new orders to rebalance
Treasury securities characteristics
- debt securities issued by us department of treasury
- paid at maturity
- risk free
- no taxes on interest income
Commerical paper
issued by corporations primarily to raiser ST funding for working capital purposes
- issuer sells at discount from FV
- variability in maturity
Reverse REPO
investor purchases securities from the dealer but has to return them one or two days later
-low maturity= no default risk
Certificate of deposit
have fixed maturity dates and are interest bearing time deposit accounts
Bankers acceptances
time draft that is guaranteed for payment by a firms issuing bank- bank accepts the payments
How to manage short term investments steps
1) determine the firm’s risk tolerance
2) establish firm risk and return
3) optimal holding strategy
4) choose best match
Value at Risk, VAR
estimate a numerical value for potential loss in value for ST inv portfolio
-assumes returns are nomrally distributed
