P2B.4 Working Capital Management Flashcards
Working Capital Formula
Management of liquidity to finance the operating cycle.
= Current assets - current liabilities
Transactional Motive
- Relates to the need for cash in day-to-day transactions; medium of exchange.
- To make payments
Precautionary Motive
- Arises from unexpected cash outflows that a company may be subjected to.
- Maintain safety cushion
Speculative Motive
- A cash reserve can be used to benefit from advantageous situations in the market.
- To take advantage of sudden opportunities.
Methods of Speeding up Cash Collections
- Lockbox system
- Concentration banking
- Payment methods; preauthorized checks, electronic transfers or automatic debits
- Payment incentives; discounts
- Factoring
Annual Lockbox Benefit Meaning & Formula
To determine if bank fees associated with a lockbox are less than the accelerated collection of cash.
= Float reduction in days * Average daily receipts * Interest rate
Methods for Slowing Down Disbursements
- Use of checks/drafts
- Zero Balance Accounts (ZBA)
- Remote disbursement
- Controlled disbursement
Marketable Securities Types
- Treasury bills, Notes and Bonds: treasury securities have less default risk.
- Repurchase agreements
- Federal Agency securities
- Bankers’ Acceptance: agreements to pay for transaction guaranteed by bank
- Commercial paper: unsecured short-term notes
- Negotiable certificate of deposits
- Eurodollar certificate of deposits
Tax Equivalent Yield
Tax-free investment vs. Taxable investment based on yield.
To determine which investment provides a higher tax-adjusted yield.
Tax Equivalent Yield Formula
= Tax-free yield / (1 - marginal tax rate)
Factors influencing the level of Accounts Receivables
- Type or Nature of Business
- Level of Sales (external)
- Credit & Collection policies (internal)
Net Benefit (Loss) on Planned Change in Credit Policy
- Benefit (increase in income) = Increase in sales * contribution margin
- Costs = Additional cost + opportunity cost of additional AR
- Cost of Additional AR = Increase in AR * Variable cost ratio * Required return
Reasons for Carrying Inventory
- To cater to sudden increase in demand.
- To reduce stock out costs
- To take advantage of volume discounts
- To buffer against unexpected failures in the production process
- To save from future price increases
Reorder Point Formula
= (Average Daily Usage * Average Lead Time in Days) + Safety Stock
Total Ordering Costs Formula
= Cost per Order * Number of Orders
= Cost per Order * (Annual Demand / Order Size)
Total Carrying Costs Formula
= Carrying Cost per Unit * Average Inventory
= Carrying Cost per Unit * (Order Size / 2)
Total Annual Cost of Inventory
= Annual Carrying Cost + Annual Ordering Cost
Economic Order Quantity (EOQ)
Optimal number of units to be purchased (or the order size) to minimize the total relevant inventory costs: total ordering costs and total carrying costs.
The assumptions made when using EOQ are:
1. The same quantity will be ordered on each order,
demand, ordering costs, and carrying costs are known and constant,
2. Purchase order lead time is known, and
3. Stockouts will not occur.
Economic Ordering Quantity (EOQ) Formula
= Sq root (2 * Annual Demand * Cost per order) / Carrying cost per Unit
Short-Term Credit Policy Approach
- Aggressive: short-term financing for both short & long term assets. An aggressive approach produces a reduced cost of borrowing to fund company operations, because short-term loans carry a lower interest rate.
- Conservative: long-term financing for both short & long term assets.
Cost of Foregoing the Discount
Annual cost of not taking a cash discount.
= D / (1-D) * 365 / N
= Discount turnover * Periodic Discount Rate
D = percentage discount offered N = number of days of the discount period
Effective Interest Rate Formula
= (1 + Periodic rate)n - 1
Periodic Rate Formula
= Periodic Discount / (1 - Periodic Discount)
Effective Annual Interest Rate of Bank Loan with Compensating Balance
= Nominal interest Due / Available Principal
= (Prin Balance * Interest Rate) / (Total Prin - Comp Balance)
