Working Capital Management

Question 1

Current Ratio

Note- Unless short-term liquidity is a Relevant Issue, the Current Ratio is not necessarily the best measure of the health of a business. Gives example of restaurant in the book. Doesn’t keep a lot of inventory, usually 1 weeks worth. Where as a book store has tons of inventory. May not be as healthy of a business.

Answer 1

Current Assets / Current Liabilities

Question 2

Quick (Acid Test) Ratio

Same as Current Ratio but Numerator does not include
PREPAIDS and INVENTORY.

Is a more rigorous test of ST liquidity than Current Ratio

Always will be

Answer 2

Cash + Marketable Securities + Receivables
___________________________________
Current Liabilities

(Inventory & Prepaids are excluded from current assets)

Question 3

In a just-in-time system

Answer 3

products are produced just-in-time to be sold.

Question 4

Net Working Capital

Answer 4

CA - CL

i.e.

Current Assets - Current Liabilities

Question 5

Inventory Turnover

Answer 5

COGS/Avg. Inventory

Question 6

Motives for Holding Cash

Answer 6

1. To meet pmts arising from ordinary course of business
2. To take advantage of temporary opportunities
3. Concern of treasurer - maintain liquidity & safety

Question 7

Disadvantages of High Cash Levels

Answer 7

1. Negative Arbitrage - int. pd on obligations > int earned from cash reserves.
2. Increased attractiveness as takeover target (CASH!)
3. Investor dissatisfied w. failure to pay dividends.

Question 8

Methods of Increasing CASH LEVELS

Answer 8

Reduce the Operating Cycle (Sell & Collect Quickly)

The objective of financial managers is to SHORTEN THE OPERATING CYCLE.

Question 9

Methods to SPEED COLLECTIONS

Answer 9

1. Customer screening & credity policy-be cautious
2. Prompt billing!
3. Payment discounts
   a. when you give to a customer - it is a cost for you
   b. when receive from a vendor & don’t take it, it’s an opportunity cost for you.

Question 10

APR OF quick payment discount

MEMORIZE THIS

Answer 10

= 360/30 - disc. per x disc %/ 100 - disc %

ex. 1/10 net 30

= (360 / 30-10) x (1% / 100% - 1%)
= (360/20) x ( 1% / 99%)
=18 x 1.01%
= 18.2%

Question 11

Cash Conversion Cycle =

Answer 11

=Inv Conv Per + Rec Collection Per - Payable Deferral Per

= “Net Operating Cycle” - # days to pay

Question 12

Inventory Conversion Period

Measures the degree to which resources have been devoted to inventory to support sales.

Answer 12

Inv. Conv. Per.= 365 / Inventory Turnover

Inv. Turnover = COGS/Avg. Inventory

High turnover =lower # of days to sell

Don’t want surplus Inventory - it does not add value!

Question 13

Receivables Collection Period =

Answer 13

= Sales / Avg. accounts receivable

Question 14

Operating Cycle =

Net Operating Cycle =

Answer 14

= # of days to sell + # of days to Collect

= Operating Cycle - # of days to pay for merch sold.

Question 15

Managing AP - “Stretch it Out” us all the time they give you

Answer 15

Defer to the max but without penalty
if they give you 30 days to pay, pay on 29th or 30th
If they give you 2/10 net 30 USE IT

Opp cost of not taking 2/10 net 30:

=(360/ 30-10) x (2% / 100% - 2%)
= 18 x .020408
= 36.7%

Question 16

A/P Turnover =

A/P Deferral Period =

Answer 16

= COGS / Avg. A/P

= 365 / AP Turnover (from above)

Question 17

Management of A/R

Answer 17

Credit Policies that determine demand of products:

1. Credit period
2. Credit standards (financial strength required of cust)
3. Collection Policy (stringent or lax in collecting delinquents)
4. Discounts - are they offered or not??

Question 18

Factoring (Selling your AR)

Answer 18

finish later, on pay B3-46

Question 19

Reorder Point Formula

Answer 19

= Safety Stock+(lead time x avg. units sold per dayorwk)

Question 20

Marketable Security with Least Risk

Answer 20

US Treasury Bills (T-Bills) (only risk is inflation)

Default Risk Free
Liquidity Risk Free
Maturity Risk Free

Question 21

Economic Order Quantity
(An Inventory Management Technique)

Order at the point where carrying costs equate nearest to restocking costs in order to minimize total inventory cost.

Annual sales is know and is a crucial part of the formula

Answer 21

This formula minimizes both ordering & carrying costs of inventory:

E = order sizE
S = annual Sales
O = cost per purchase Order (primarily production setup)
C = Carrying cost per unit

where:

E = the square root of (2 S O) / C

Question 22

Long-Term Assets should be financed

Short-term Assets (like A/R, Inventory)shd be financed

Answer 22

with long-term debt

with short-term debt

Question 23

Better controls of cash receipts might include

Answer 23

Concentration banking - one bank for all receipts
Expedite deposits-EFT, Lockbox system, 
Prompt billing
Customer Screening
Payment Discounts??

Question 24

Factoring your Accounts Receivables

Answer 24

Improves your A/R turnover ratio. You get immediate payment, however, you give up part of your receivables

Question 25

Materials Requirement Planning (MRP) is

Answer 25

an inventory management technique that projects and plans inventory levels in order to control the usage of raw materials in the production process. MRP primarily applies to work in process and raw materials