Working capital management Flashcards
what is the objective of working capital finance
to minimize the cost of maintaining liquidity while guarding against the risk of insolvency
Working capital policy applies to long-term decisions. True or false
False
working capital policy applies to short-term decisions; capital structure finance applies to long-term decisions
permanent working capital is
the minimum level of current assets maintained by a firm
should increase as the firm grows
generally is financed with long-term debt
a firm that adopts a conservative working capital policy seeks to
minimize liquidity risk by increasing working capital
forgoes the potentially higher returns from investing in long-term assets
reflected in a higher current ratio
a firm that adopts an aggressive working capital policy seeks to
increase profitability while accepting liquidity and a higher risk of short-term cash flow problems
lower current ratio
three motives for holding cash
- transactional (as a medium of exchange)
- precautionary (to provide a reserve for contingencies)
- speculative (to take advantage of unexpected opportunities)
what is cash float
the period from when a payor mails a check until the funds are available in the payee’s bank
strategies to decrease float time for receipts
-lock box system
-concentration banking
annual benefit of speeding up cash collections
(daily cash receipts x days of reduced float) x opportunity cost of funds
disbursement float
the period from when the payor writes a check until the funds clear and are deducted from the payor’s account
what is a compensating balance
the minimum amount that a bank requires to keep frozen in its account
incur opportunity costs because they are unavailable for investment purposes
strategies for managing cash outflows
-overdraft protection
-zero balance accounts
-centralizing accounts payable
-controlled disbursement accounts
what are the most important aspects of marketable securities management?
-achieving an optimal risk and after-tax return trade-off
-liquidity
-safety
increased investment in receivables formual
incremental variable costs x (incremental average collection period / days in year)
cost of a change in credit terms formula
increased investment in receivables x opportunity cost of funds
the benefit or loss resulting from a change in credit terms calculation
incremental contribution margin - cost of change
the _____ limit of a company’s credit period is the operating cycle of the purchaser
upper
if the credit period is longer than the purchaser’s operating cycle, the seller is financing more than just the purchaser’s inventory needs
what are the four components of costs related to inventory
- purchase costs (actual invoice amounts charged by suppliers or the investment in inventory)
- carrying costs (includes the opportunity cost of funds invested in inventory)
- ordering costs (cost of placing an order with a vendor)
- stockout costs (the opportunity cost of missing a customer order)
maintaining safety stock increases carrying costs. True or false
True
what are the two components of the total cost of carrying safety stock
expected stockout costs + carrying cost
economic order quantity (EOQ) model
a mathematical means of determining the order quantity.
minimizes the sum of ordering costs and carrying costs
how changes in variables affect the EOQ solution
assumptions of the EOQ model
-demand is uniform
-carrying costs are constant
-the same quantity is ordered at each reorder point
-purchasing costs are unaffected by the quantity ordered
-sales are perfectly predictable
-lead time is known with certainty
-deliveries are consistent
-adequate inventory is maintained to avoid stockouts
What are statements that characterize U.S. Treasury bills
-they have no coupon rate because they are sold at a discount
-they are backed by the full faith and credit of the United States government, so there is not default risk
-the interest received is subject to federal income tax
The level of safety stock in inventory management depends on:
-level of customer dissatisfaction for back orders
-level of uncertainty of the sales forecast
-cost of running out of inventory
Average daily collection of checks for a firm is $40,000. The firm also writes on the average $35,000 of checks daily. If the collection period for checks is 5 days, calculate the net float
$25,000
the difference between the collections and payables is $5,000 daily. Five days’ worth amounts to $25,000 of float
The optimal level of inventory is affected by what factors?
-the periodic demand for inventory
-the carrying cost, which includes the interest on funds invested in inventory
-the usage rate
-the cost of placing an order or making a production run
