Working Capital Management

Question 1

Describe primary and secondary sources of liquidity

Answer 1

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.

Question 2

Describe factors that influence a company’s liquidity position.

Answer 2

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

Question 3

Drags on liquidity

Answer 3

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.

Question 4

Pulls on liquidity

Answer 4

accelerate cash outflows. Examples include paying vendors sooner than is optimal and changes in credit terms that require repayment of outstanding balances.

Question 5

current ratio

Answer 5

CA / CL

Question 6

quick ratio or acid-test ratio

Answer 6

(cash + short term marketable securities + receivables) / CL

Question 7

receivables turnover

Answer 7

credit sales / ave. receivables

Question 8

number of days of receivables (also called average days’ sales outstanding)

Answer 8

365 / receivable turnover

Question 9

inventory turnover

Answer 9

COGS / ave. inventory

Question 10

average inventory processing period or number of days of inventory

Answer 10

365 / inventory turnover

Question 11

What does is mean if the inventory turnover is too high or too low compared to the industry norm?

Answer 11

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period that is too high might mean that too much capital is tied up in inventory and could mean that the inventory is obsolete.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.

Question 12

payable turnover ratio

Answer 12

purchases / ave. trade payable

Question 13

payables payment period or number of days of payables

Answer 13

365 / payable turnover ratio

Question 14

operating cycle

Answer 14

average number of days that it takes to turn raw materials into cash proceeds from sales

Question 15

operating cycle formula

Answer 15

days of inventory + days of receivables

Question 16

cash conversion cycle or net operating cycle

Answer 16

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

Question 17

cash conversion cycle =

Answer 17

ave. days receivables + ave. days inventory - ave. days payables

Question 18

Operating and cash conversion cycles that are high relative to a company’s peers suggest what?

Answer 18

That the company has too much cash tied up in working capital.

Question 19

What is the daily cash position?

Answer 19

It refers to uninvested cash balances a firm has available to make routine purchases and pay expenses as they come due.

Question 20

Cash inflows include

Answer 20

operating receipts, cash from subsidiaries, cash

received from securities investments, tax refunds, and borrowing.

Question 21

Cash outflows include

Answer 21

purchases, payroll, cash transfers to subsidiaries, interest, and principal paid on debt, investments in securities, taxes paid, and dividends paid

Question 22

What is the purpose of managing a firms daily cash position?

Answer 22

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.

Question 23

% discount from face value =

Answer 23

(FV - P) / FV

Question 24

discount-basis yield (bank discount yield or BDY) =

Answer 24

[(FV - P) / FV]x[360/t]

Question 25

HPY =

Answer 25

(FV - P) / P

Question 26

MM yield =

Answer 26

HPY x (360/t)

Question 27

Choices of short-term funding available to a company

Answer 27

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:

1. Commercial paper.
2. Bank lines of credit.
3. Collateralized borrowing.
4. Nonbank financing.
5. Factoring.