test III: managing working capital

Question 1

working capital

Answer 1

• difference between a business’s current assets and current liabilities
• short-term assets and liabilities required to operate a business on the day-to-day
  ex. : cash, ar, ap, accruals

Question 2

accruals

Answer 2

expenses not yet paid or revenues not yet billed

Question 3

current accounts (gross or net)

Answer 3

gross working capital: current assets

networking capital: current assets - current liabilities

Question 4

purpose of working capital management

Answer 4

• optimize the use of short-term assets and liabilities
• maintain just enough liquidity to meet short-term obligations and then invest a maximum towards growth
• a company with an excessively high current ratio could indicate a failure to invest in growth opportunities

Question 5

funding requirements

Answer 5

working capital requires funds
- maintaining a working capital balance requires a permanent commitment of funds
- companies must always maintain minimum amounts of short-term assets
spontaneous financing
- accounts payable
- accruals

Question 6

the objective of working capital

Answer 6

• always run the company with as little money as possible tied up in working capital
• maintaining low working capital allows a firm to invest in growth strategies (acquisitions and improvements)
• risk: firm can run out of cash or inventory (hurt reputation)

Question 7

trade-offs

Answer 7

profitability 
low levels: lower wc
high levels: higher wc
risk
low levels: lower wc
higher levels: higher wc

Question 8

objectives of cash management

Answer 8

maintain liquidity to: take cash discounts, maintain the firm’s credit score, minimize interest costs and avoid insolvency

Question 9

the operating cycle and the cash conversion cycle

Answer 9

inventory holding + receivables collection period = operating cycle
receivables collection period - payable payment period = cash conversion cycle

Question 10

cash conversion cycle

Answer 10

• the time from the purchase of inventory to the cash collection of the sales
• depending on the industry, the ccc may be longer or shorter (donuts vs airplanes)
• cash > inventory and labour > sales > ac > cash

Question 11

ratios: inventory holding period

Answer 11

365 / inventory turnover

how many days a firm will hold inventory

Question 12

ratios: receivable collection period

Answer 12

average accounts receivable for the year x 365 / annual credit sales
how many days it takes for the firm to receive payments from their credit sales

Question 13

ratios: payable payment period

Answer 13

average accounts payable for the year x 365 / cogs

how many days the firm takes to pay its credit purchases

Question 14

managing accounts receivable

Answer 14

policies

1. credit policy
2. terms of sales
3. collections policy

Question 15

trade-offs in receivable management: liberal

Answer 15

more sales and gross margin 
more bad debts
higher collection period
more discount expenses
higher receivables
longer collections 
more interest expense

Question 16

trade-offs in receivable management: strict

Answer 16

fewer sales and gross margin
less bad debts
lower collection period 
less discount expenses
lower receivables
lower collections 
less interest expense

Question 17

credit policy

Answer 17

examining the creditworthiness of potential credit customers
- credit report, customer’s financial statements, bank references, customer’s reputation among other vendors, credit scores

Question 18

terms of sales

Answer 18

credit sales are made according to specified terms of sales

- ex.: 2/10 means 2% discount if paid in 10 days, otherwise has to be paid in 30 days

Question 19

collection policy

Answer 19

how the firm intends to treat the delinquent customers who delay their payments

• too lenient: withhold payments
• too severe: damage customer relations

Question 20

inventory management

Answer 20

how much inventory to hold (proper balance)

• too much: expensive
• too little: lost sales

Question 21

benefits and costs of carrying adequate inventory

Answer 21

reduces stockouts and backorders

• smooth operations, improve customer relations and increase sales
  goal: optimize carrying costs and ordering costs

Question 22

carrying costs

Answer 22

all costs to having inventory on hand
- interest on funds used to acquire inventory, storage and security, insurance, taxes, shrinkage, spoilage, breakage, obsolescence

Question 23

ordering costs

Answer 23

all costs of ordering/transportation

- fuel, duty taxes, placing orders, insurance, receiving shipments and processing materials to inventory

Question 24

economic order quantities (EOQ) model

Answer 24

• carrying costs increase with the amount of inventory held (from larger orders)
• ordering costs increase with the number of orders placed (from more orders)
• the EOQ minimizes the total sum of ordering and carrying costs

Question 25

safety stock

Answer 25

additional inventory that is kept on hand for sudden demands or difficulty in obtaining inventory

Question 26

lead time

Answer 26

the time delay before receiving stock

short/just-in-time: minimal amounts of inventory

Question 27

reorder points

Answer 27

order will be automatically be placed with the supplier when inventory reaches a precise low point

Question 28

just-in-time

Answer 28

inventory is supplied at exactly the right time and exactly the right quantities
- reduces the need for high factory inventory
- shortens operating cycle
- reduces costs
- eliminates wasteful procedures
buyers might be too dependent

Question 29

sources of short term financing

Answer 29

spontaneous financing
bank operating loans
secured loans for accounts receivable and inventory
money market instruments

Question 30

spontaneous financing

Answer 30

accounts payable (no security and are largely interest-free)

Question 31

bank operating loans

Answer 31

the most commonly used source of short-term financing

- granted based on a firm’s collateral

Question 32

short term financing vs long term financing

Answer 32

short: cheap but risky
long: safe but expensive

Question 33

revolving credit

Answer 33

legally commits the bank thereby making the funds a certainty for the firm

• secured with collateral
• commitment fees if they don’t use it

Question 34

line of credit

Answer 34

non-biding as it may be revoked by the bank

- predetermined ceiling

Question 35

prime rate

Answer 35

the rate that a bank charges its largest and most creditworthy corporate customers

Question 36

interest rates on operating loans

Answer 36

based on the bank’s prime rate plus a risk premium

- competition, size, credit history, reliable cash flow, etc.

Question 37

collateral: accounts receivable

Answer 37

pledging receivables: promising to repay the loan once the receivables are collected
factoring receivables: selling the receivables at a discount to the buyer/creditor (factor)

Question 38

collateral: inventory

Answer 38

blanket inventory lien: promising to repay the loan once the inventory is sold
trust receipt: the lender identifies the inventory which can’t be sold without permission from the lender
warehousing: inventory is seized (warehoused) by the lender until the sale