Treasury Management - Cash flow & Terms of Payment

Question 1

What are the components of cash flow?

Answer 1

The components of cash flow are:
– Days Inventory Held (DIH)
– Days Sales Outstanding (DSO) day’s receivable (shorter the better)
– Days Payables Outstanding (DPO) day’s payables (longer the better)
–The cash cycle is: DIH + DSO – DPO *
–The operating cycle is: DIH + DSO
* The cash cycle is also called the cash conversion period (CCP)

Question 2

Tell me about some ratios***

Answer 2

 Days’ inventory held (DIH)
Average delay that the inventory is held for (On average it took x days to turn inventory into revenue):
Inventory / Cost of goods sold/365
 Days sales outstanding (DSO)
Average delay to collect account receivables
– Account Receivables/Sales/365
 Days payables outstanding (DPO)
Average delay to pay the suppliers:
– Accounts payables/Cost of goods sold/365

Question 3

How can we free cash from the cycle?

Answer 3

Decrease CCP*, this means that we would
shorten the period where financing is requested
– At best we could have a negative CCP which
means that money (A/R’s) is collected before
suppliers are paid (A/P’s)
Therefore decrease DIH & DSO and increase DPO

Question 4

Tell me about Financing CCP - types of operating line

Answer 4

 In order to finance CCP companies usually
draw of their operating line
 This line can be:
– committed, which means that the Financial
Institution that provides it is engaged if certain
conditions are met;
– Uncommitted, means that the Financial
Institution can cancel it without prior notice

Question 5

Financing CCP – what will Financial institution require the

Operating facility to guarantee when giving credit:

Answer 5

Usually the Financial institution will require the
Operating facility to be guaranteed either by:
– Accounts receivables, some may be carved out
– Inventory, depending on the nature its value
will need to be assessed

Question 6

Tell me about the Aging Schedule - look at A/R listing

Answer 6

 Is a list of the percentage and/or amounts of
outstanding A/R classified as current or past due.
 Used primarily to identify past due accounts.
 Can be prepared at the aggregate level or
customer-by-customer.
 Subject to distortions due to sales variations.

Question 7

Name me some Reasons to offer Credit

Answer 7

 Competition
 Market Share
 Promotion
 Credit Availability to Customers
 Customer Convenience
 Profit

Question 8

What are some cost associated with a Credit policy?

Answer 8

Credit Department Costs
 Credit Evaluation Costs
 A/R Carrying Cost
 Discounted Payments
 Selling and Production Cost
 Collection Expenses
 Bad Debts

Question 9

How to tell if one company is more liquid than another?

Answer 9

• Speed
• One has access to a line of credit
• Look at account receivable

Question 10

What are some Terms of payment goals?

Answer 10

– Accelerate the collection of A/R’s
– Increase sales
– Decrease marginal accounts (bad clients)
– Spread the financing
– Decrease inventory
– Become more competitive
– Increase market share
– Make sales force more accountable
– Credit availability to customers
– Customer Convenience

Question 11

What are objectives of Credit management?

Answer 11

They look after account receivables, they establish and communicate credit policies, they evaluate customers and set credit line, look at billing and deal with accounts that are overdue.

Question 12

What are some terms of payments?**(types of trade credit arrangement better suppliers and buyers)

Answer 12

– Cash before delivery (CBD) (made to specification)
– Cash on delivery (COD) (ex:grocery store)
– Consignment (jewelry , magazine they get back what have not been sold, item is sold payment is due)
– Open Account (one tab like the bars)
– Money discount
– Volume discount (buy 1 get 1 50% off- urban)
– Floor financing (car industry)
– Seasonal dating (what to have it before the season)

Question 13

Tell me about Cost of Trade Credit**

Answer 13

 From a seller’s viewpoint, the cost of the discount must be weighted against the benefit of receiving early payment.
 From buyer’s viewpoint, the cost of trade credit is an
opportunity cost.
 A buyer should take the discount if its cost of borrowing is less than the cost of declining the discount.
 Alternatively, a buyer should decline the discount if
investment rates are higher than the cost of foregoing the discount.

Question 14

What are the cost of holding cash and What are 5 motives to hold cash?**

Answer 14

1. Opportunity cost and agency cost.

 Transaction: to be able to pay when deadline
arrives without waiting for inflow of cash
 Precaution: for unexpected needs (Taxis)
 Speculation: allows to move quickly and benefit
from opportunities
Then you also have taxes motives and agency problems

Question 15

What is the Cash Conversion Cycle? **

Answer 15

is a measure of the firms liquidity that represents the number of days it takes to move the funds from inventory to receivables and from receivable to cash, after accounting for payable period. CCC= DIH + DSO - DPO

Question 16

What refers to DIH (Days’ inventory held)**

Answer 16

Is the gap between placement and delivery of order. This ratio will tell you it took x day to convert revenue into inventory

Question 17

What refers to DSO (Days’ sales outstanding)**

Answer 17

Is the time period between the delivery of order and the receipt of payment, which is influence by the trade credit period that the seller offered too the buyer. This ratio will tell you it took x days to to collect one each sales

Question 18

What is the Operating cycle?**

Answer 18

Is the sum of the DIH + DSO

Question 19

What are the caveats regarding cash conversion cycle?

Answer 19

1. It doesn’t say anything at the individual sales transaction.
2. seasonal variations may lead to inaccurate inference
3. it might not be relevant in future periods.
4. it is rare, but you can achieve a negative CCC. Where payable fund inventory, receivable and long-term assets (Apple and Walmart).

Question 20

What are the assumptions that management should take into account with any valuation problems?

Answer 20

1. Apply the appropriate discount rate.
2. The duration of the change in the working capital policy.
3. assume a constant sale-growth rate.

Question 21

What are solvency measures?

Answer 21

it is used to assess the efficiency of working capital management useing NWC, WCR and current ratio.

Question 22

What is the formula of Net working capital (NWC) ?

Answer 22

NWC = current asset - current liabilities. If NWC=0 implies that current liabilities fully fund current assets. a positive NWC implies that long-term financing was used to fund a proportion of current asset. Negative NWC implies that current liabilities fully funded current asset and some long-term assets. ***NWC can increase due to problem with inventory or problems with collecting A/R. Therefore, it provides no conclusive evidence regarding firm’s liquidity.

Question 23

What is thee formula for working capital requirement (WCR)?

Answer 23

current operating asset (ex: inventory and receivable) - current operating liabilities (ex: accrued and payable). A positive WCR would mean that $ of financing is required to fund the investment of current operating assets.

Question 24

What is the formula of current ratio?

Answer 24

Current asset/current liabilities. Basically indicates the lvl of coverage that current asset provides to short term creditors in the event of financial distress.

Question 25

What is lambda?

Answer 25

Is a improved liquidity measure that ignores liquidity provided by credit line and the effect of cash flow volatility.

Question 26

What interrelated trends can causes DSO to decrease?

Answer 26

1. Minimizing of working capital.
2. Improvement in internal and external credit related information
3. Growth in electronic commerce.