Working Capital Management (W12)

Question 1

Operating Cycle

Answer 1

Average length of time between when a firm purchases its inventory and when it receives the cash back from selling its product.

Question 2

Cash Cycle

Answer 2

Length of time between when the firm pays cash to purchase its initial inventory and when it receives cash from the sale of the output produced from that inventory.

Question 3

Cash Conversion Cycle =

Answer 3

Inventory Days + A/R Days - A/P Days

Question 4

What does 2/10, n 30 mean?

Answer 4

2% cash discount, 10 day discount period. Credit period = 30 days

Question 5

Cost of Trade Credit =

Answer 5

EAR equation

Question 6

Reasons to offer trade credit (3)

Answer 6

Indirect way to lower prices for only certain customers
More information about the credit quality of the customer than the traditional outside lender.
Inventory can be used as collateral.

Question 7

Determining Credit Policy (3)

Answer 7

Establish credit standards
Establish credit terms
Establish a collection policy

Question 8

5 C’s of Credit

Answer 8

Character
Capacity
Capital
Collateral
Conditions

Question 9

Accounts Rec. Days

Answer 9

Average number of days it takes a firm to collect on its sales

Question 10

Aging Schedule

Answer 10

Categorise accounts on the number of days that it has been on the firms books, can be prepared using either the number of accounts or the dollar amount of the accounts outstanding.

Question 11

Payment Pattern

Answer 11

Provides information on the percentage of the monthly sales that the firm collects in each month after the sale.

Question 12

Strategies for when a firm ignores payment due period and pays later

Answer 12

Cash on Delivery (COD)
Cash Before Delivery (CBD)

Question 13

Benefits of Holding Inventory (2)

Answer 13

Helps avoid stock outs
Addresses seasonality in demand

Question 14

Cost of Holding Inventory (3)

Answer 14

Acquisition Costs
Order Costs
Carrying Costs

Question 15

Alternative to Holding Inventory

Answer 15

JIT inventory management
JIC Inventory management

Question 16

Motivation for Holding Cash (3)

Answer 16

Transactions Balance - to meet day to day needs
Precautionary balance - to compensate fro the uncertainty associated with its cash flows
Compensating balance - to satisfy bank requirement

Question 17

Reasons for short-term financing (3)

Answer 17

Negative cash flow stocks - temp negative for unexpected reason
Positive cash flow stocks - unexpected increased sales req. ST finance for marketing and production
Seasonality - concentration of sales

Question 18

The Matching Principle

Answer 18

Short term needs should be financed with short term debt and long term needs should be financed with long-term sources of funds.

Question 19

Permanent Working Capital

Answer 19

The amount that a firm must keep invested in short-term assets to support continuing operations

Question 20

Temporary Working Capital

Answer 20

Difference between the actual level of investment in short-term assets and the permanent working capital investment.

Question 21

Aggressive Financing Policy (2)

Answer 21

Financing part or all of the permanent working capital with short term debt
Funding risk

Question 22

Conservative Financing Policy (2)

Answer 22

Funding short term needs with long-term debt
Non-productive use of cash

Question 23

Single, End of Period Payment Loan

Answer 23

Benchmark rate, or the secured overnight financing (SOFR)

Question 24

Bridge Loan

Answer 24

Offer discount loan with fixed interest rate, borrower pays interest at the beginning of the loan period

Question 25

Common Loan Stipulations & Fees

Answer 25

Commitment Fees
Loan Origination Fee
Compensating Balance Requirements

Question 26

Commercial Paper (5)

Answer 26

Short-term unsecured debt used by large corporations
Usually cheaper than short-term bank loan
Min Face Value $25000
Max Face Value $100000
Interest typically paid by selling it at an initial discount.

Question 27

Secured Loans

Answer 27

Loans collateralised with short term assets - usually Acc Rec or Inventory

Question 28

Acc Rec as Collateral (2)

Answer 28

Pledging - lender reviews invoices and decides which it will accept as collateral
Factoring - firm sells receivables to the lender, lending pays the firm amount due at the end minus factor’s fee.

Question 29

How inventory can be used as Collateral (3)

Answer 29

All of the inventory is used to secure the loan
Trust receipts loan - distinguishable items held in trust as security
Warehouse arrangement - all inventory that serves as a collateral stored in a separate warehouse.