Working Capital Management Flashcards
Define raw materials, WIP and FG
RM- inventory held for use in the production process
WIP- inventory in production but incomplete
FG- production inventory that is complete and ready for sale
What is the formula for net realizable value?
net selling price - costs to complete and dispose
AKA the market ceiling
What is a periodic inventory system?
- when inventory quantities are determined by physical counts performed at least annually
- COGS determined after each count: beginning inventory + purchases - ending inventory
What is a perpetual inventory system?
- the inventory balance is updated for each purchase and each sale and is always current
- COGS determined and recorded with each sale
What is the FIFO cost flow assumption?
- first costs inventoried are the first costs transferred to COGS
- ending inventory includes the most recently incurred costs and approximates replacement cost
- perpetual and periodic inventory systems can be used
What is the LIFO cost flow assumption?
- the last costs inventoried are the first costs transferred to COGS
- COGS higher, NI and WC will be lower
- ending inventory does not aproximate replacement cost because ending inv includes the oldest inventory
- perpetual and periodic inventory systems can be used
What is the weighted average cost flow assumption?
- calculates an average cost per item at the end of the period by: total costs of inventory available/ total number of units of inventory available
- used for both the ending inv balance and COGS
- works with a periodic inv system
What are the burdensome carrying costs resulting from excessive inventory?
- storage costs
- insurance costs
- opportunity costs of inventory investment
- lost inventory due to obsolescence or spoilage
- the lower the carrying costs, the more inventory companies are willing to carry
What are the concepts related to the determination of the optimal level of inventory?
- inventory turnover
- safety stock
- reorder point
- economic order quantity
- materials requirements planning
The determination of safety stock depends on the following factors:
- reliability of sales forecasts
- possibility of customer dissatisfaction resulting from back orders
- stockout costs (the cost of running out of inventory), including loss of income, the cost of restoring goodwill with customers and the cost of expedited shipping to meet customer demand
- lead time (the time that elapses from the placement to the receipt of an order)
seasonal demands on inventory
What is the reorder point and its formula?
- the inventory level at which a co. should order or manufacture additional inventory to meet demand and to avert incurring stockout costs
- safety stock + (lead time * sales during lead time)
What is the Kanban inventory control?
- give visual signals that a component required in production must be replenished
- prevents oversupply or interruption of the manufacturing process as the result of lacking a component
What is the computerized inventory control?
- establishes real-time communication links between the cashier and the stock room
- every purchase is recognized instantaneously by the inv database, as well as every return
- computers are programmed to alert inventory managers as to reorder requirements
- some databases interface directly with supplier software toa llow for instantaneous reorders, removing the human element
What is Integrated Supply Chain Managment (ISCM)?
- exists when a firm and the entire supply chain (suppliers, producers, distributors, retailers, customers, service providers) are able to reasonably predict the expected demand of consumers for a product and then plan accordingly to meet that demand
- a collaborative effort between buyers and sellers
- the goal is to better understand the needs and preference of customers and cultivate the relationship with them
What is the Supply Chain Operations Reference (SCOR) model?
- assists a firm in mapping out its true supply chain and then configuring it to best fit the needs of the firm
What are the 4 key mgmt processes/core activities pertaining to SCOR?
Plan- developing a way to properly balance demand and supply within the goals/objectives of the firm and prepare for the necessary infrastructure
Source- once demand has been planned, it is necessary to procure the resources required to meet it and to manage the infrastructure that exists for the sources
Make- encompasses all the activities that turn the raw materials into finished products that are produced to meet a planned demand
Deliver- encompasses all the activities of getting the finished product into the hands of the ultimate consumers to meet their planned demand
What are the 3 motives for holding cash?
Transaction motive- a co. may hold cash to meet payments arising from the ordinary course of business
Speculative motive- cash may be needed to take advantage of temporary opportunities
Precautionary motive- it is important to have enough cash on hand to maintain a safety cushion to meet unexpected needs
What are the 3 disadvantages of high cash levels?
- the “negative arbitrage” effect (interest obligations exceed interest income from cash reserves)
- increased attractiveness as a takeover target
- investor dissatisfaction with allocation of assets (failure to pay dividends)
What are the 4 credit policy variables?
- Credit period- the length of time buyers are given to pay for their purchases. If period is too long, there may be cash shortages. If too short, may damage relationships with customers and negatively affect furture sales.
- Credit standards- refers to the required financial strength of credit customers. Extending only to financially strong customers minimizes uncollectible receivables, but limits potential sales. Extending credit to a broader base of customers increases sales, but a greater percentage of receivables are likely to be written off.
- Collection policy- measured by its stringency or laxity in collecting delinquent accounts. A balancing act between wanting to collect cash owed quickly vs maintaining positive relationships with customers
- Discounts- includes the discount percentage and period. offering discounts ro customers who pay early may result in faster receivables collection, depending on the terms of the discount and the customer’s own cash needs and capacity to pay early
What are methods to speed collections?
- customer screening and credit policy
- prompt billing
- payment discounts
- expedite deposits (EFTs and lockbox systems)
- concentration banking
What are short term financing characteristics?
- current; will mature within one year
- rates tend to be lower than LT rates and presume greater liquidity on the part of the organization using ST financing
- effect on working capital- current liability, decreases WC
What are ST financing advantages/disadvantages?
Advantages:
- increased profitability
- decreased financing cost (lower interest rates than LT interest rates)
Disadvantages:
- increased interest rate risk
- decreased capital availability
What are long term financing characteristics?
- non current; will mature after one year
- rates tend to be higher than ST rates and presume less liquidity on the part of the org using LT financing
- effect on working capital: not included in the calc of WC as it is non current but dividend, interest and principal repayments all require cash which can reduce WC over time; increases financial leverage
What are LT financing advantages/disadvantages?
Advantages:
- decreased interest rate risk
- increased capital availability
Disadvantages:
- decreased profitability
- - increased financing costs (interest rate risk: lender’s perspective and interest rate risk: borrower’s perspective)
