Module 35.1: Working Capital Management

Question 1

What is a company’s primary source of liquidity?

Answer 1

sources of cash in normal day-to-day operations.

cash balances from selling

short term funding lines like line of credit

effective cash flow management

Question 2

What are secondary sources of liquidity?

Answer 2

liquidating short-term or long lives assets, negotiating debt agreements, or filing for bankruptcy.

Question 3

What are drags on liquidity vs. pulls on liquidity?

Answer 3

drags on liquidity reduce cash inflows, or increase borrowing costs. examples include bad debts, obsolete inventory, and tight short term credit.

pulls on liquidity accelerate cash outflows and include paying vendors sooner than is optimal and changes in credit terms that require repayment of outstanding balances.

Question 4

What is the current ratio? what does a higher current ratio imply?

Answer 4

current assets / current liabilities, higher current ratio means the company will be able to pay its short-term bills.

Question 5

what is the quick ratio? also what does it imply?

Answer 5

quick ratio = cash + short term marketable securities + receivables / current liabilities.

Question 6

What is the formula for receivables turnover? what amount is desirable?

What is the sales for number of days of receivables outstanding?

Answer 6

credit sales / average receivables, best to have turnover close to the industry norm.

number of days of receivables
= 365 / receivables turnover
= average receivables / average day’s credit sales

Question 7

What is the formula for inventory turnover? number of days of inventory?

Answer 7

cost of goods sold / average inventory

365 / inventory turnover or average inventory / average day’s COGS.

Question 8

What is the formula for payables turnover ratio? for number of days of payables?

Answer 8

purchases / average trade payables

365 / payables turnover ratio = average payables / average day’s purchases

Question 9

what is the operating cycle?

Answer 9

days of inventory + days of receivables

Question 10

What is the cash conversion cycle? are high cash conversion cycles considered desirable?

Answer 10

average days of receivables + average days of inventory - average days of payables

high conversion cycles are not desirable, too high implies that the company has

Question 11

What is a company’s daily cash position?

Answer 11

refers to un-invested cash balances a firm has available to make routine purchases and pay expenses as they come due.

Question 12

What is the formula for % discount to face value of a short term security?

Answer 12

face value - price / face value

Question 13

what is the formula for discount basis yield (bank discount yield)

Answer 13

% discount x 360/days

or

(face value - price) / face value * 360 / days

Question 14

What is the formula for money market yield? for bond equivalent yield?

Answer 14

money market yield = (face value - price) / price * 360/days

bond equivalent yield = (face value - price) / price * 365/days to maturity

Question 15

Is the information available to compare a firm’s aging schedule and weighted average collection period with other firms?

Answer 15

No

Question 16

What’s the best way to indicate that a firms inventory is too large?

Answer 16

increasing average days of inventory and decreasing inventory turnover.

Question 17

What is the formula to evaluate not taking the discount of early payment?

Answer 17

cost of trade credit = [ [1 + ( % discount / 1 - % discount)] ^ 365 / days past discount ] - 1

Question 18

What is the formula for number of days payables? average day’s purchases?

Answer 18

number of days payables = accounts payable / average day’s purchases

average day’s purchases = annual purchases / 365

Question 19

What is an uncommitted line of credit, a committed line of credit, and revolving line of credit?

Answer 19

uncommitted - A bank extends an offer of credit for a certain amount but may refuse to lend if circumstances change.

committed - cannot change, typically for periods less than 1 year.

revolving line of credit - typically longer term than committed and more reliable.