Working Capital Management Flashcards
What are some motives for a company to hold cash?
transaction motive - holding 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 is a credit policy?
it is one of the major determinants of demand for a firm’s products or services, along with price, product quality, and advertising; the credit policy of a company is typically established by a committee of senior company executives; credit policy variables include: credit period (the length of time buyers are given to pay for their purchases), credit standards (the required financial strength of credit customers), collection policy (a company’s stringency or laxity in collecting delinquent accounts), and discounts (the discount percentage and period)
methods to speed collections include: customer screening and credit policy, prompt billing, payment discounts, expedite deposits (EFT and lockbox systems), and concentration banking (characterized by the designation of a single bank as a central depository)
What is factoring?
factoring AR entails turning over the collection of AR to a third-party factor in exchange for a discounted short-term loan; cash is collected from the factor immediately rather than from the customer according to the credit terms
Inventory management
inventory may represent the most significant current noncash resource of an organization; inventory typically is most significant in businesses that involve the sale or manufacture of goods
inventory can be classified as raw materials, WIP, or finished goods
inventory depends on the accuracy of sales forecasts; lack of inventory can result in lost sales, and excessive inventory can result in burdensome carrying costs (including: storage costs, insurance costs, opportunity costs of inventory investment, and lost inventory due to obsolescence or spoilage)
the lower the carrying costs of inventory, the more inventory companies are willing to carry
What is safety stock?
it helps a company ensure that manufacturing or customer supply requirements are met; it depends on the reliability of sales forecasts, seasonal demands on inventory, possibility of customer dissatisfaction resulting from back orders, stockout costs (the cost of running out of inventory) and lead time (the time that elapses from the placement to the receipt of an order)
What is reorder point?
it is the inventory level at which a company should order or manufacture additional inventory to meet demand and to avoid incurring stockout costs; the reorder point can be calculated using the formula below:
reorder point = safety stock + (lead time * sales during lead time)
What is economic order quantity (EOQ)?
ordering costs typically represent the costs of labor associated with order placement; the costs are driven by order frequency
the EOQ inventory model attempts to minimize total ordering and carrying costs; the model can be applied to the management of any exchangeable good; EOQ assumes that demand is known and is constant throughout the year, so EOQ does not consider stockout costs, nor does it account for costs of safety stock; EOQ also assumes that carrying costs per unit and ordering costs per unit are fixed
e = square roof of: 2so/c
E = order size (EOQ)
S = annual sales in units
O = cost per purchase order
C = annual carrying cost per unit
What is a just-in-time (JIT) inventory model?
it was developed to reduce the lag time between inventory arrival and inventory use; it ties delivery of components to the speed of the assembly line; it reduces the need of manufacturers to carry large inventories, but requires a considerable degree of coordination between manufacturer and supplier; the benefits of JIT implementation include tying production scheduling with demand, more efficient flow of goods between warehouses and production, reduced setup time, and greater employee efficiencies
What is computerized inventory control?
it operates by establishing real-time communication links between the cashier and the stock room; every purchase is recognized instantaneously by the inventory database, as is every product return
What is Kanban inventory control?
it gives visual signals that a component required in production must be replenished; this technique prevents oversupply or interruption of the entire manufacturing process as the result of lacking a component
What is supply chain management/integrated supply chain management (ISCM)?
it exists when a firm and the entire supply chain are able to reasonably predict the expected demand of consumers for a product and then plan accordingly to meet that demand; ISCM is a collaborative effort between buyers and sellers
the goal of ISCM is to better understand the needs and preferences of customer and cultivate the relationship with them
What is the supply chain operations reference (SCOR) model?
it assists a firm in mapping out its true supply chain and then configuring it to best fit the needs of the firm; there are 4 key management processes or core activities pertaining to SCOR: plan, source, make, and deliver
What is trade credit (aka accounts payable)?
it generally provides the largest source of short-term credit for small firms; trade credit represents the purchases of goods and services as part of usual and customary business transactions for which payment is made 30-45 days after acquisition
accruals are another common form of short-term credit (transactions that remain unpaid and period end purely as a result of timing)
although extension of payments under trade credit arrangements can be very effective in preserving cash balances and financing current operations, the effective annual interest cost can be extremely high if discounts are offered and foregone as part of this working capital management strategy
the formula for calculating the annual cost (APR) of a quick payment discount (assuming a 360 day year) follows:
APR of quick payment discount = (360 / [pay period - discount period]) * (discount % / [100% - discount %])
the decision whether or not to pay early and take the discount depends on several factors, including whether the company has the cash on hand to pay that particular vendor early, the company wants to preserve its cash position for other purposes (investments, projects, maintaining a reserve, etc.), or if there is potential to negotiate even more favorable terms with vendors, including greater discounts or longer discount periods
a couple of methods to delay disbursements include deferring payments (communication to creditors that payment will arrive late helps mitigate possible damage to credit ratings) and using a line of credit with a bank
What are corporate banking arrangements?
debt involves risk, but it also provides management with the funds needed for operations and growth; one source of debt is borrowing from banks and other lending institutions that offer various forms of credit to companies
What is a letter of credit?
it represents a third-party guarantee, generally by a bank, of financial obligations incurred by the company; it represents an external credit enhancement used by a company issuing otherwise unsecured debt to enhance its credit or can be required by a creditor to ensure payment
