B3: Financial Management (Working Capital Management)
What is the formula for quick (acid-test) ratio?
(Cash + Marketable securities + Recievables)/ Current liabilities
Define just-in-time inventory model.
- "Pull approach" developed to reduce the lag time between inventory arrival and inventory use
What are the variables of credit policy?
1. Credit period 2. Credit standards 3. Collection policy 4. Discounts
What are the primary methods of increasing cash levels through speeding cash collections?
1. Customer screening and credit policy 2. Prompt billing 3. Payment discounts 4. Expedite deposits (Electronic funds transfer or Lockbox systems) 5. Concentration banking 6. Factoring accounts receivable
What are the primary methods of increasing cash levels through delaying disbursements?
1. Defer payments 2. Drafts 3. Line of credit 4. Zero-balance accounts
Which factors help determine the optimal level of inventory?
1. Inventory turnover 2. Safety stock 3. Reorder point 4. Economic order quantity ("EOQ") 5. Materials requirements planning
What are some other cash management techniques?
1. Managing float 2. Overdraft protection 3. Compensating balances
What are the determining factors of safety stock?
1. Reliability of sales forecasts 2. Possibility of customer dissatisfaction resulting from back orders 3. Cost of running out of inventory 4. Lead time (the time that elapses from the placement to the receipt of an order) 5. Seasonal demands on inventory
What are the factors that influence inventory levels?
1. Sales forecasts 2. Storage costs 3. Insurance costs 4. Opportunity costs of inventory investment 5. Lost inventory due to obsolescence or spoilage
What are some disadvantages of high cash levels?
1. The "negative arbitrage" effect (interest obligations exceed interest income from cash reserves) 2. Increased attractiveness as a takeover target 3. Investor dissatisfaction with allocation of assets (failure to pay dividends)
What is the formula for the annual cost (APR) of a quick payment discount?
360/ (Pay period - Discount period) x Discount/ (100 - Discount %)
Define transaction motive.
A company may hold cash to meet payments
What is the interpretation of the current ratio?
A higher current ratio is generally better; measures liquidity at a point in time
Define speculative motive.
Cash may be needed to take advantage of temporary opportunities
What is the formula for the payables deferral period?
Cost of goods sold/ Average accounts receivable = Accounts payable turnover 365/ Accounts payable turnover
What is the formula for the inventory conversion period?
Cost of goods sold/ Average inventory = Inventory turnover 365/ Inventory turnover
How is net working capital calculated?
Current assets less, current liabilities
What is the formula for current ratio?
Current assets/ current liabilities
What is the formula for EOQ?
E = Sq.Rt. [(2 x Annual sales x Order cost)/ Carrying cost per unit]
Which marketable security has the most risk?
Equity securities of public companies because of the volatility of the stock market
What is the formula for the cash conversion cycle?
Inventory conversion period + Receivables collection period less, Payables deferral period
Define precautionary motive.
It is important to have enough cash on hand to maintain a safety cushion to meet unexpected needs
What is the relationship between working capital and risk?
Less working capital increases risk by: a. Exposing a company to the likelihood of a possible failure to meet current obligations b. May reduce a firm's ability to obtain additional short-term financing
What factors influence the level of marketable securities?
Liquidity and credit hedge (a precaution against a possible shortage of bank credit)
Define conservative working capital management.
More current assets financed by noncurrent liabilities
Define aggressive working capital management.
More current assets financed with current liabilities
When should marketable securities be held?
Periods of high rates
What is the formula for reorder point?
Safety stock + (Lead time x Sales during lead time)
What is the formula for the receivables collection period?
Sales/ Average accounts receivable = Accounts receivable turnover 365/ Accounts receivable turnover
What are the assumptions of EOQ?
assumes that demand is known and is constant throughout the year assumes that carrying costs and ordering costs are fixed
Define deteriorating current ratio.
decline in the current ratio implies a reduced ability to generate cash
Define United States Treasury Bills.
default risk-free, liquidity risk-free, and maturity risk-free; therefore are the safest securities on the market
Define trade credit.
generally provides the largest source of short-term credit for small firms
Define improving current ratio.
increase in the current ratio implies an increased ability to pay off current liabilities and may be attributable to using long-term borrowing to repay short-term debt
Define economic order quantity.
inventory model attempts to minimize both ordering and carrying costs
Define cash conversion cycle.
length of time from the date of the initial expenditure for production to the date cash is collected from the customers and the vendors are paid for the initial expenditures
Define safety stock.
maintained to ensure that manufacturing or customer supply requirements are met
What do marketable securities provide?
much lower returns than operating assets but higher returns than cash
What is a limitation of the current ratio?
not the best measure of the health of a business
What is the objective of working capital management?
shareholder wealth maximization
Define reorder point.
the inventory level at which a company should order or manufacture additional inventory to meet demand to avert incurring stockout costs
Define current ratio.
way of measuring short-term solvency
Define working capital ratios.
working capital policy and working capital management involve managing cash so that a company can meet its short-term obligations, and include all aspects of the administration of current assets (CA) and current liabilities (CL)