Working Capital Management (W12) Flashcards
Operating Cycle
Average length of time between when a firm purchases its inventory and when it receives the cash back from selling its product.
Cash Cycle
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.
Cash Conversion Cycle =
Inventory Days + A/R Days - A/P Days
What does 2/10, n 30 mean?
2% cash discount, 10 day discount period. Credit period = 30 days
Cost of Trade Credit =
EAR equation
Reasons to offer trade credit (3)
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.
Determining Credit Policy (3)
Establish credit standards
Establish credit terms
Establish a collection policy
5 C’s of Credit
Character
Capacity
Capital
Collateral
Conditions
Accounts Rec. Days
Average number of days it takes a firm to collect on its sales
Aging Schedule
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.
Payment Pattern
Provides information on the percentage of the monthly sales that the firm collects in each month after the sale.
Strategies for when a firm ignores payment due period and pays later
Cash on Delivery (COD)
Cash Before Delivery (CBD)
Benefits of Holding Inventory (2)
Helps avoid stock outs
Addresses seasonality in demand
Cost of Holding Inventory (3)
Acquisition Costs
Order Costs
Carrying Costs
Alternative to Holding Inventory
JIT inventory management
JIC Inventory management
Motivation for Holding Cash (3)
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
Reasons for short-term financing (3)
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
The Matching Principle
Short term needs should be financed with short term debt and long term needs should be financed with long-term sources of funds.
Permanent Working Capital
The amount that a firm must keep invested in short-term assets to support continuing operations
Temporary Working Capital
Difference between the actual level of investment in short-term assets and the permanent working capital investment.
Aggressive Financing Policy (2)
Financing part or all of the permanent working capital with short term debt
Funding risk
Conservative Financing Policy (2)
Funding short term needs with long-term debt
Non-productive use of cash
Single, End of Period Payment Loan
Benchmark rate, or the secured overnight financing (SOFR)
Bridge Loan
Offer discount loan with fixed interest rate, borrower pays interest at the beginning of the loan period
Common Loan Stipulations & Fees
Commitment Fees
Loan Origination Fee
Compensating Balance Requirements
Commercial Paper (5)
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.
Secured Loans
Loans collateralised with short term assets - usually Acc Rec or Inventory
Acc Rec as Collateral (2)
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.
How inventory can be used as Collateral (3)
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.
