Working Capital Management Flashcards
Describe primary and secondary sources of liquidity
Primary sources of liquidity are the sources of cash a company uses in its normal operations.
If its primary sources are inadequate, a company can use secondary sources of liquidity such as asset sales, debt renegotiation, and bankruptcy reorganization.
Describe factors that influence a company’s liquidity position.
A company’s liquidity position depends on the effectiveness of its cash flow management and is influenced by drags on its cash inflows and pulls on its cash outflows
Drags on liquidity
delay or reduce cash inflows, or increase borrowing costs. Examples include uncollected receivables and bad debts, obsolete inventory (takes longer to sell and can require sharp price discounts), and tight short-term credit due to economic conditions.
Pulls on liquidity
accelerate cash outflows. Examples include paying vendors sooner than is optimal and changes in credit terms that require repayment of outstanding balances.
current ratio
CA / CL
quick ratio or acid-test ratio
(cash + short term marketable securities + receivables) / CL
receivables turnover
credit sales / ave. receivables
number of days of receivables (also called average days’ sales outstanding)
365 / receivable turnover
inventory turnover
COGS / ave. inventory
average inventory processing period or number of days of inventory
365 / inventory turnover
What does is mean if the inventory turnover is too high or too low compared to the industry norm?
A processing period that is too high might mean that too much capital is tied up in inventory and could mean that the inventory is obsolete. A processing period that is too low might indicate that the firm has inadequate stock on hand, which could hurt sales.
payable turnover ratio
purchases / ave. trade payable
payables payment period or number of days of payables
365 / payable turnover ratio
operating cycle
average number of days that it takes to turn raw materials into cash proceeds from sales
operating cycle formula
days of inventory + days of receivables
cash conversion cycle or net operating cycle
the length of time it takes to turn the firm’s cash investment in inventory back into cash, in the form of collections from the sales of that inventory
cash conversion cycle =
ave. days receivables + ave. days inventory - ave. days payables
Operating and cash conversion cycles that are high relative to a company’s peers suggest what?
That the company has too much cash tied up in working capital.
What is the daily cash position?
It refers to uninvested cash balances a firm has available to make routine purchases and pay expenses as they come due.
Cash inflows include
operating receipts, cash from subsidiaries, cash
received from securities investments, tax refunds, and borrowing.
Cash outflows include
purchases, payroll, cash transfers to subsidiaries, interest, and principal paid on debt, investments in securities, taxes paid, and dividends paid
What is the purpose of managing a firms daily cash position?
The purpose of managing a firm’s daily cash position is to have sufficient cash on hand (that is, make sure the
firm’s net daily cash position never becomes negative) but to avoid keeping excess cash because of the interest income foregone by not investing the cash.
% discount from face value =
(FV - P) / FV
discount-basis yield (bank discount yield or BDY) =
[(FV - P) / FV]x[360/t]
HPY =
(FV - P) / P
MM yield =
HPY x (360/t)
Choices of short-term funding available to a company
The choice of short-term funding sources depends on a firm’s size and creditworthiness.
Sources available, in order of decreasing firm creditworthiness and increasing cost, include:
- Commercial paper.
- Bank lines of credit.
- Collateralized borrowing.
- Nonbank financing.
- Factoring.
