Chapter 8 - Working Capital Mgmt

Third Party Financing

A company collects the information necessary to complete a credit application from a customer and forwards it to a financial institution. The FI decides whether to grant credit. Frees up capital, the company relinquishes control over the credit-granting decision foregoes direct marketing opportunities. May have to discount the price of goods sold to compensate the third party, foregoing potential income.

Revolving Credit

A company grants credit without requiring specific transaction approval, as long as the account remains current. If not paid in full by the due date, an interest charge is calculated based on the average amount outstanding over the entire period.

Information Sources

A company must consider the type, quantity, and cost of information when establishing a method for analyzing credit requests. __ __ include: applicants financial statements, trade references, banks or other financial creditors, credit rating agencies.

Card Payments

A company receives a payment, less the merchant discount, one to two business days following the transaction.

Operating Cycle (Cash Conversion Cycle)

A company's daily operating activities create a flow of cash through the various working capital accounts which is called it's ______________. -Borrow or liquidate investments -Purchase supplies -Build inventory -Provide/sell services and products -Collect revenues -Invest or pay down borrowings

Obsolete

A company's inventories may become ____ or damaged, especially in environments where there are rapid changes in existing products or introductions of new products. Inventory that is no longer salable through normal channels because it is out of date or has been replaced with newer products. Must still be tracked and eventually written off or sold at discount to get it off the books.

Trade Credit

A contractual arrangement allowing a customer to take possession of a good, product, or service now and pay for it later. The company, in turn, receives a promise of future payment from the buyer, which is the basis for entering the sale as an AR. Payment is due per the agreed-upon credit terms extended to the customer. This increases sales.

Hybrid

A disbursement system is a _____ when the local or regional managers oversee the AP process and authorize payments at a local level, but the actual disbursement of payments is managed centrally and drawn on a centralized disbursement bank.

Discriminant Analysis

A formal statistical method that can identify factors the effectively distinguish between paying and nonpaying customers, sometimes on a region-by-region basis.

Current Ratio

A high value here suggests a strong liquidity position. = Current Assets / Current Liabilities

Supply Chain Financing

A seller receives financing based upon the existence of sales contracts and purchase orders with large, financially stable, trading partners.

Disbursement System

A set of procedures that determines who may authorize payments, where and when the payments originate, how potential fraud is controlled, and how accounts are reconciled. Actually sends out the payments.

Multi-currency Account

A special arrangement between a bank and a company where the bank lets the customer receive or make payments in a range of currencies from a single account or multiple subsidiary accounts. The agreement generally specifies four stipulations: 1. Base currency 2. Portfolio of currencies accepted 3. Spread or margin over the spot rate to use in exchanging each currency back to base currency 4. The value date to apply to debris and credits for each transaction type and currency.

Private Label Financing

A third party operates the credit function in the seller's name rather than the seller administering a credit program in-house. The credit appears to be arranged through the seller, but it's not. Sellers retain many of the promotional aspects of conducting credit functions while incurring none of the costs of maintaining a credit operation and/or financing AR. Does not receive the full value of the sale and loses authority to decide who gets credit.

Floor Planning

A type of asset-based lending used for high-value durable goods; Loans are made against each individual item, recorded by serial number, and are not fully repaid until the item is sold.

Netting

An internal company payables system that is designed to reduce the number of cross-border payments among company units through the elimination or consolidation of funds denominated in different currencies thus enhancing natural hedging. Three benefits: 1. Reduction in the number of FX transactions 2. More favorable FX rates 3. Improved cash and currency exposure forecasting

Re-Invoicing

An intracompany method of centralizing the responsibility for monitoring and collecting international AR to more effectively manage related FX exposures. A company owned subsidiary that purchases goods from an exporting subsidiary and sells the goods to an importing subsidiary. The exporting unit invoices and receives funds from the re-invoicer in it's own currency, and the importing unit is invoiced and pays funds to the re-invoicer in it's own currency. The title passes through the re-invoicing center, but the goods are shipped directly between the exporter and importer.

Fluctuating Current Assets

Anything over the lowest amount of current assets a company has had in the past several years.

Current Assets

Assets that are expected to be converted to cash within one year.

Just-in-Time Inventory (JIT)

Attempts to minimize inventory levels by reducing the costs or uncertainties that underlie the motives for holding inventory. Recognizes that excess inventory can be a liability rather than an asset. Not simply an inventory management system, but a production/business philosophy that treats inventory as being undesirable.

Asset-based Lending

Based on the value of the inventory rather than the borrower's general financial strength. To enforce the claim on the inventory, the lender usually takes physical possession of it if the company defaults on the loan or files for bankruptcy.

Cash Conversion Cycle

Begins when inventory is purchased and ends when available funds are collected from A/R. The average number of days between the cash outflow for the acquisition of material and supplies and the cash inflow from the sale of products or services. A method for calculating the average length of time a company must finance a cash outflow before receiving a cash inflow. = Days' Inventory + Days Receivables - Days' Payables

Payment Discrepancies

Can arise from customers paying multiple invoices -- each with possible adjustments -- with a single payment. The costs associated with monitoring, investigating, and resolving discrepancies between invoices and customer payment can be substantial.

Scrap

Can be reused in later inventory batches or sold to recycles. A normal by-product of many manufacturing processes.

Collection Policies

Creating __ __ involves determining the steps involved to collect delinquent accounts or bad debts. Often based on industry standard practices; as a result can be difficult to differ from competitors. May impact loan covenants, working capital ratios, and legal constraints.

Trade Credit (AP)

Credit granted by suppliers; typically the least expensive alternative and finances a significant portion of inventory.

Credit Terms

Establishing __ __ involves designing sales contracts or agreements that clearly specify under what condition these are granted. Once the collection policies are set, a company must develop an information system or purchase software that monitors AR to ensure compliance with __ __ and to detect changes in customer payment patterns at aggregate and individual customer levels.

Asset-based Lending

If a company cannot finance AR with unsecured borrowings, it may pledge AR as collateral and borrow on a secured basis. Based on the quality of receivables. A lender evaluates the receivables to determine those acceptable as collateral for a loan, which is repaid as the company collects the receivables.

Discount Terms

If a company offers ___ ___, then the "cost" of these payments affects income. If offered, the company must determine a benchmark eligibility date.

Benchmark Eligibility

If a discount is offered, this is often the postmark date of the payment remittance or the date funds are received.

Current Account

If the current credit outstanding is below an established credit limit and minimum payments are made on time.

Discount Terms

In addition to specifying a net due date, the seller may offer a discount on payments made prior to that date. Terms of 2/10 net 30 mean that the total amount is due within 30 days of the invoice date, but the buyer can take a 2% discount if it pays within 10 days.

Timing of Payments

In disbursement system; means Ensuring payments are not made before their due date.

Relationship Maintenance with Payee

In disbursement system; means ensuring timely payments to payees.

Fraud Prevention

In disbursement system; means protecting company funds from unauthorized use, through written policies and internal controls, prompt bank reconciliation, and appropriate banking services.

Float-Neutral Terms

In some cases, a buyer will agree to electronic payment rather than paper-based if the seller agrees to these terms, where either the timing (i.e., value date) of the payment is adjusted or a discount is offered so as to maintain whatever float the buyer was receiving with the paper payment. Discount = 1 - (1 / (1+Total Days Difference(opportunity cost @ annual rate/365)))

Inventory Policy

Includes elements such as: 1. Reasons for holding inventory 2. Types of inventory 3. Levels of inventory 4. Obsolescence and spoilage 5. Benefits and costs of inventory

Spoilage

Inventory that is no longer salable due to damage or other defects that occur over time. Must eventually be disposed of through write offs or through some form of discounted sale.

Concentration Flows (Funding Flows)

Involve internal transfers among operating units of a company and between a firm's various bank accounts, with the objectives of pooling funds for other purposes or funding various disbursement accounts.

Liquidity Management Flows

Involve using the organization's liquidity reserves in the most effective manner (i.e., investing excess funds, paying down on debt, drawing on debt resources, selling off investments).

Credit Scoring

Involves a four-step process: 1. Differentiating standard and high risk accounts based on the applicant's monthly income, outstanding obligations, and employment history 2. Weighting the characteristics of applicants who fit into each category to establish creditworthiness 3. Setting cutoff scores for clear approval or denial of credit 4. Applying further analysis to applicants whose scores fall between the cutoff points

Lagging

Involves executing cross-border payments between subsidiaries after the scheduled date; employees when a subsidiary country's currency is expected to appreciate relative to the parent company's currency.

Leading

Involves executing cross-border payments between subsidiaries before the scheduled date; employed when a subsidiary country's currency is expected to depreciate relative to the parent company's currency.

Three-Way Match

Involves matching an invoices to both an approved purchase order, as well as receiving and in some cases, shipping information. Verification ensures the items being billed are authorized, from an approved vendor, and that all items are received in satisfactory condition.

Factoring

Involves the outright sale of receivables; a company that specializes in the financing and management of receivables. Buyer of the receivables has no recourse to the seller. Mostly performed on a notification basis, meaning the seller must notify customers that the account has been sold because payment is remitted directly to the factor.

Accounts Receivable (A/R)

Is created once a sale is made and trade credit is extended

Financial Distress

It is critical to monitor each credit account over time for potential ____ _____. This monitoring should involve the tracking of payments and level of credit outstanding, as well as monitoring news and press releases issued by the customer.

Inventory

Levels of __ include: 1. Just in time 2. Supplier-managed replenishment programs 3. Paid on production

Colleralized Loans

Loans arranged using inventory as collateral for loan, with the lender providing financing for some predetermined percentage of the inventory's value. The company's cash flows are viewed as the primary repayment source, and inventory is viewed as a secondary repayment source or a means of reducing the amount of loss in the event of default.

Stock-Out Costs

Lost sales due to a lack of sufficient inventory. Inventory reduces this risk.

No Recourse

Means that the factor must absorb the loss if a customer fails to pay.

Accounts Receivable

Methods for financing __ __ include: 1. Asset-based lending 2. Securitization 3. Captive finance companies 4. Third-party financing 5. Card payments 6. Factoring 7. Private Label financing

Multinational

Methods of managing working capital on a __ basis: 1. Netting a. Bilateral Netting b. Multilateral Netting c. Leading payments d. Lagging payments 2. Reinvoicing 3. Internal Factoring 4. In-House Banking 5. Export Financing

Open Item System

Most commonly used in B2B sales; each invoice sent to a customer is recorded in the AR file. When a payment is received, it is matched with the specific invoices being paid. Any payment discrepancies are noted.

Information Access

Obtaining access to timely and accurate information regarding the status of disbursement accounts and disbursement clearings to manage cash more effectively.

AR Management

Occurs after credit has already been extended. Includes billing, posting remittance information, monitoring payment patterns, and collecting delinquent accounts. Proper management include: -Creating, preserving, and collecting AR -Maintaining up to date customer records -Initiating collection procedures on past-due accounts

Material Planning Systems (MPS)

Often coupled with JIT systems that bring together long-range production planning with the current flow of materials through the production process.

Inventory

One primary reason for holding _____ is to provide the goods required for expected sales levels during normal operating and production cycles. Can also be held as a precautionary measure, for speculative purposes, and to meet supplier requirements. Definition: Any item held in stock that links two or more production processes.

Income / Expense

Potential sources of __ related to granting credit include: interest earned from installment payment arrangements, penalty fees for past due payments. Potential sources of __ related to granting credit include: carrying costs, personnel costs, data and payment processing costs, and costs related to credit evaluations.

Paid-On-Production Process

Process by which a payment record is created for goods and/or services based on usage rather than shipment. Title to the product is transferred during the manufacturing process rather than at the shipping doc.

Information Float

Refers to the inability to use, generate, or apply cash due to a delay in receiving related information. The time between receiving good funds and the time the org knows that it has the funds available and can actually make use of those funds.

Works in Process (WIP)

Represents items or materials that are in the process of being manufactured. Allows different phases of the production process to be separated. Also serves as a butter between production stages with different processing speeds.

Raw Materials

Represents the basic input to the manufacturing process and allows arrivals to be separated from production scheduling.

Permanent Current Assets

Represents the certain minimum amount of current assets that a company must have to do business; one way of identifying it is to examine the balance sheet and determine the lowest amount of current assets that a given company has had in the past several years. Because the company can reasonably assume that, barring major problems, the value of its current assets will not fall below this base, it can consider financing current assets with longer-term debt.

Opportunity Cost

Represents the cost of funds for any of the alternatives discussed. The most common is weighted average cost of capital (WACC), but may not be appropriate for working capital decisions because it's generally used for long-term capital cost calculations. For short-term, should determine what the most attractive unused alternative is for any funds or balances that are generated as a result of the decision.

Capacity

Represents the current and future financial resources a company or individual has available to pay obligations when they come due. This factor can be assessed using financial liquidity ratios and cash flow forecasts.

Invoicing Float

Represents the delay between the purchase of goods or services and the receipt of an invoice by the buyer/payor. Major components include order entry and billing system delays, as well as mail float. Can be reduced with e-commerce and other technology tools.

Payment Float

Represents the delay between the time an invoice is sent/received and the time the funds have been transferred between accounts and is available/deducted. (includes collection and disbursement float). Includes collection/disbursement float, but the biggest portion if related to the customer's payables policy and the negotiated trade terms. Can be reduced by e-commerce and effective management of trade terms.

Disbursement Float (Buyer/Payor)

Represents the interval or delay between payment initiation and the day funds are debited from the buyer/payer's account. Analogous with collection float. Includes mail, processing and clearing float.

Collection Float (Seller/Payee)

Represents the time interval or delay between payment initiation and the time the funds are received and available. Includes: mail, processing, and availability float. Primary cost is opportunity cost because uncollected funds cannot be used to pay down debt. Can be reduced with RDC or LBX services.

Cash Before Delivery (CBD)

Require the buyer to make full and final payment before the shipment or receipt of goods. B2C = catalog, telephone, or internet sales B2B = when the seller does not know the buyer or when the seller considers the buyer a greater credit risk than the seller is willing to accept. Reduces the potential for bad debt.

Installment Credit

Requires a customer to make equal periodic payments, each of which contains principal and interest components; used frequently for the purchase of high-value consumer durables. Is liquidating, in the normal parents will eventually pay off the balance of the account over time.

Profitability Measures

Return on sales, return on total assets, and return on equity

Financed

Since AR must be __, a company's ability to extend credit related directly to its ability to borrow. Mismanagement of AR can cause liquidity problems, but can also be a source of liquidity when used as collateral for asset-based loans or when sold to factors for cash.

Cash Flow Timeline

Spans the interval that begins with the purchase of raw materials or parts from the vendors and suppliers at the start of the operating cycle and ends when payment is received from customers at the completion of the operating cycle. Includes the PTP, inventory, and OTC timelines.

Rule

The ____ in cash management is to collect quickly and disburse slowly, within the constraints of prudent business practices and the maintenance of good relations with trading partners and other stakeholders.

Merchant Discount

The amount a credit card company (or acquiring bank) charges a seller for there service. Amount varies depending on the method of transmission, average size of the sale, total volume, type of card used, and business or industry type.

Credit

The amount of _____ available as a percentage of the inventory's value, depends on the nature of the inventory, its location, when and where transfer of title occurs, and the existence of a secondary market. Usually not available for WI inventory, but rather for raw materials and finished goods. Methods include: 1. Trade credit 2. Supply chain financing 3. Collateralized loans 4. Asset-based loans 5. Floor planning

Days' Payables (Payables Conversion Period)

The average number of days between the purchase/receipt of materials or supplies and issuance of payment for them.

Days' Receivables (Receivables Conversion Period)

The average number of days required to convert a sale into a collection.Changes in A/R policies and any changes in the competitive marketplace may impact this metric. Related to Days' Sales Outstanding which measures the average amount of credit sales that are in A/R.

Days' Inventory (Days' Sales in Inventory)

The average number of days that elapse from the purchase of raw materials until the sale of finished goods. The average number of days that: -Raw materials remain in inventory -Raw materials are converted into finished goods -Finished goods remain in inventory In retail -- the average length of time that finished goods inventory is held before sale.

Cash Terms

The buyer generally has 7-10 days to make payment. Frequently used in the sale of perishable items or in cases where the buyer has not established credit history with the seller.

Liquidity Ratios (Working Capital)

The current, quick, and cashflow to total debt ratios

Current Asset

The extent of the company's uncertainty and risk tolerance determines its investment levels in ______ ______ accounts; in other words, its ____ ____ investment strategy. Selection of strategy may also depend on industry practices.

Export Financing

The government (Export Credit Agencies - ECAs) supports export activities through export loans, credit guarantees, or combinations of both.

Collection Policy

The major objective of the ____ ____ is to cover AR to cash quickly, while minimizing collection expense and bad debt losses.

Working Capital Management

The management of business and financial process aimed at maximizing or creating shareholder value by optimizing the cash locked in short-term assets and liabilities. Involves the analysis of the risk/reward relationships that attach to different strategies. Involves balancing the need for liquidity against the lower rate of return to decide what level of liquidity is appropriate for a particular business or industry.

Open Account (Open Book Credit)

The most common type of commercial trade credit. A seller issues an invoices as formal evidence of the obligation and records the sale as an AR. The buyer is billed for each transaction by an invoice and/or monthly statement. Full payment of invoiced amounts is expected within the specified credit terms unless certain discounts or deductions are available to the buyer.

Letter of Credit

The most complex form of credit extension; most commonly used in import/export transactions.

Cash Turnover

The number of times cash is converted over a full year; the higher this figure is, the better. A lower CCC = higher CT = 365 / Cash Conversion Cycle

Inventory Managment

The objective is to minimize the total costs associated with the inventory while meeting a desired level of production and/or customer service.

Disbursement Float (Collection Float, Float)

The period of time that occurs between the creation of a payment and the actual time when the payment is credited in good funds to the payee's account. Typically the smallest piece of float. A portion of payment float, and includes: 1. Mail Delay 2. Processing Delay 3. Availability Delay

Cash Application

The process of applying a customer's payment against outstanding invoices or receivables.

Seasonal Dating

The seller agrees to accept payment at the end of the buyer's selling season. This lets a manufacturer provided short-term financing for a buyer's purchases and reduces the manufacturer's inventory costs. Common in industries with distinct seasonality of sales such as toys, greeting cards, garden supplies, sporting

Recourse

The seller is liable meaning the seller must notify customers that the account has been sold because payment is remitted directly to the factor.

Monthly Billing

The seller issues a monthly statement covering all invoices prior to cutoff date, typically toward the end of each month. If the seller extends proximo (prod, meaning in the following month) payment terms then the buyer must pay a specified date during the following month.

Cash on Delivery (COD)

The seller ships the goods and buyer pays upon receipt. If the buyer refuses to pay the goods are returned and the seller must pay the shipping and handling costs.

Net Terms

The seller specifies a net due date (benchmark eligibility date) by which the guyer must pay in full. (e.g., net 30 requires the buyer to pay within 30 days from the date of invoice, date of delivery, or some other specified date.)

Consignment

The supplier (consignor) ships goods to another party (cosignee) who has no obligation to pay util the goods have been sold. The supplier retains title to the goods until they are sold, at which time title is transferred to the ultimate buyer. The cosignee will then deduct any commission or fees and forward the remainder to the supplier.

Supplier-management replenishment Programs

The supplier maintains and tracks the inventory of materials it provides to a customer. As the inventory is used, the supplier bills the customer for the items and replenishes the supply. Title is transferred at the shipping dock.

Clearing Float

The time interval between the day when a check is deposited by the payee and the day when the payer's account is debited. Usually occurs at the same time, but if a bank requires funding same day for ACH, could vary.

Mail Float

The time interval between the time the day a payment (and any related remittance information) is mailed and the day it is received by a payee or at a payee's processing site.

Availability Float

The time interval or delay between the day when a payment is deposited into a bank account and the day when the payee's account is credited with collected funds.

Processing Float

The time interval or delay between the time the payee or the payee's processing site receives the payment and the time the payment (typically a check) is deposited to the payee's account.

Float

The time interval, or delay, between the start and completion of a specific phase or process occurring along the cash flow timeline. Often the result of wait time and inefficiencies within a specific process, but is also often increased by the use of paper processes and delivery systems. Includes: 1. Payment float a. Collection float (mail, processing, availability) b. Disbursement float (mail, processing, clearing) 2. Invoicing Float 3. Information Float

Credit Extension

There are 4 basic forms of __ __: 1. Open Account 2. Installment Credit 3. Revolving Credit 4. Letter of Credit (L/C)

Cash Flows

There are 4 types of __ __: 1. Cash Outflows (funds disbursed, purchase-to-payables) 2. Cash Inflows (funds collected, order-to-cash) 3. Concentration/funding flows (internal transfers) 4. Liquidity Management flows (setting liquidity reserves)

Economic Order quantity (EOQ)

These models are typically used to calculate the optimal level of inventory, given specified ordering and holding costs. Can be difficult to apply because they do not account for variables such as volume discounts and blanket purchase orders that cover a schedule of deliveries.

Quantitative Analysis

This analysis of business credit information begins with an examination of a credit applicant's financial statements, usually using ratio analysis to assess a customer's financial conditions. Measures often include: liquidity, working capital, debt management and coverage ratios, as well as profitability measures.

Aggressive

This current asset financing strategy finances all fixed assets with long-term debt and equity, but finances only a portion of permanent current assets with long-term financing. Short-term financing supports the remainder of the permanent current assets and all temporary current assets. Utilizes more ongoing short-term financing than other financing strategies.

Conservative

This current asset financing strategy finances fixed assets, permanent current assets, and some portion of fluxing current assets with long-term financing. A company usually tries to finance the average level of fluctuating current assets with long-term sources. Short-term financing is used for the remainder of the fluctuating current assets. Has higher financing costs than other approaches because long-term debt is carried when it is not needed.

Maturity Matching

This current asset financing strategy finances the total of permanent current assets and fixed assets with long-term financing (e.g., debt and equity). Short-term financing is used to finance fluctuating current assets. As fluctuating assets expand, drawing on the line of credit increases to support that expansion. When assets decline, funds are released and are used to pay down the line of credit.

Restrictive

This current asset investment strategy describes a company that maintains low levels of current assets relative to sales. In particular, this strategy may affect sales negatively, as well as the selection of goods available to consumer demand. Is the most profitable as long as unexpected events do not drive down liquidity to the point that it causes severe problems. More risky.

Relaxed

This current investment strategy describes a company that maintains high levels of current assets relative to sales; typically in high levels of inventory and AR. Likely to lower investment returns, but the firm operates with less risk because of its larger liquid asset balances.

Conditions

This factor assesses the general, existing economic environment that impacts a customer's ability to pay or the willingness of a company to grant credit.

Collateral

This factor identifies available assets or guarantees used to secure an obligation in the event that payment terms are not met.

Character

This is the perceived honesty or integrity of an individual applicant or a corporate applicant's officers. Indicates an intent or willingness to pay, as evidenced by personal or corporate payment history.

Current Asset Financing

This strategy is a basic decision non whether to place great reliance on short- or long-term sources of funding. ST Debt: enables a firm to adjust the amount of financing to the fluctuation in current assets so it never has excess financing and never pays interest unnecessarily (revolver) LT Debt: guarantees financing over the course of several years, however, the firm has excess financing and pays interest unnecessarily during the year if the amount of borrowing is at or approaches the estimated need when fluctuating current assets peat. Methods include: 1. Maturity Matching 2. Conservative 3. Aggressive

Order-to-Cash Timeline

This timeline is a cash inflow and represents the final piece of the operating cycle. Includes all of the tasks involved in soliciting customers and converting inventory into sales and ultimately into cash. Timeline includes: 1. Source customers 2. Quote price 3. Negotiate Sales Terms 4. Manage credit 5. Receive Purchase order 6. Ship goods and send invoices 7. Receive payment 8. Reconcile and account 9. Analyze and review

Inventory

This timeline represents the process of acquiring raw materials and parts, converting them into finished goods, storing the goods as inventory, and shipping the goods. For retail this cycle is considerably faster; for services, the filling of an order may be immediate. Timeline includes: 1. Raw materials 2. Works in progress 3. Finished goods

Purchase-to-Pay

This timeline represents the time from the purchase of raw materials, retail goods or services until the payment is received and collected. Timeline includes: 1. Source suppliers 2. Select supplier and goods 3. Negotiate Payment Terms 4. Arrange credit 5. Send purchase order 6. Receive goods and invoice 7. Send payment 8. Reconcile and account 9. Analyze and review

Revolver

This type of credit agreement lets companies borrow on a short term basis, yet classify the loan as LT for accounting purposes. Does not reduce the current ratio, as does borrowing under a traditional ST loan. Prevents the issue of needing to renew ST lending annually, and reduces the risk that ST financing will not be made available to a firm should a bank need to ration it's credit amongst customers.

Finished Goods

This type of inventory consists of completed items or materials available for sale, and lets a company fill orders when received rather than depend upon product completion to satisfy customer demand. Can manage highly variable or unpredictable demand levels more easily.

Credit

To ensure consistent application and fairness, companies should maintain written __ policies and procedures that clearly define their: 1. Credit Standards 2. Credit Terms 3. Discount Terms 4. Collection Policies

In-House Banking

Treasury becomes the main provider of banking services for all the company's operating entities. Individual transactions of various subsidiaries can be aggregated, netted, and processed in bulk, resulting in fewer transactions and lower fees.

Consumer Billing

Typically involves sending statements listing goods or services purchased during the preceding month.

Gross Method

Under this discount method, gross revenues are recorded on the income statement and in receivables, and discounts are recorded as an expense.

Balance Forward System

Used most often by companies selling goods and services to individual consumers. A credit limit is established for each individual. AR outstanding balances increase as purchases are made or services are provided. AR balances decrease as payments are received, but payments are not matched to specific purchases.

Centralized

A disbursement system is _____ when the AP and disbursement functions are located in a single place; a company receives all inbound invoices, approves them for payment, issues payments and funds and reconciles accounts. Potentially negative impact on payees and branches lose autonomy.

Decentralized

A disbursement system is _____ when the AP and disbursement functions are managed at the local or regional level. Field office managers approve invoices for payment, issue payments, and reconcile accounts.

Dunning Letters

A series of form letters notifying a customer they are past the due date.

Credit Management

Administers policies that establish credit standards, defines the terms of trade credit extension, approves customers for credit sales, and sets individual and aggregate credit limits within policy guidelines.

The Five Cs of Credit

Character, Capacity, Capital, Collateral, and Conditions

Captive Finance Company

Companies establish a whole owned subsidiary to perform credit operations and obtain AR financing for the sale of products. Enhances the parent's liquidity and provides access to capital at a lower cost.

Current Assets

Decisions about how to finance permanent and fluctuating __ __ define a company's working capital financing strategy. The strategy a company selects depends upon: (1) The company's risk/return tradeoff characteristics (2) Industry practices (3) Interest rate differentials among short, intermediate, and long term debt (yield curve)

Multilateral Netting

Each subsidiary informs a central treasury management center of all planned cross-border payments through an electronic system. To determine netting transactions, payments between all subsidiaries are converted into a common currency and combined into a few larger transactions. Each unit is informed of the net amount owed or due in advance of the settlement date, and the central treasury management center makes the necessary FX conversions. Requires a common (base) currency.

Electronic Data Interchange (EDI)

For those industries and companies that have realigned trading partner relationships and reengineered supply chain management, the trend is to replace checks with electronic payment methods and to replace paper invoices with ____, thereby eliminating all paper-based float delays.

Current Liabilities

Generally refers to liabilities that are required to be paid for within one year.

Yield Curve

Graphs the interest rate differentials among short-, intermediate-, and long-term debt; illustrates whether it is less expensive to borrow money from the money markets or banks continuously, or to lock in an intermediate- or long-term rate by obtaining a term loan or accessing funds via capital markets. ST financing typically costs less than LT financing because this is upward sloping most of the time.

Net Method

In this discount method, net revenues are recorded on the income statement and in receivables. Any discounts not taken are shown as income.

Remittance

Indicates which invoices are being paid, as well as any adjustments to the payments.

Stores and Supplies (Indirect Purchases)

Items not used directly, rather they support the production process.

Securitization

Large companies (particularly those with installment loans) bundle and issue securities backed by receivables. This is a financing method that frees up a company's capital and enhances its creditworthiness by using consumers' installment payments to pay off the securitized instrument's principal and interest. A variation of this practice is to sell the AR to an intermediary FI who packages the accounts and securitizes them.

Documentary Collection (Draft/Bill of Lading)

Lets a seler collect payments through bank channels; is more common in international than domestic trade. The seller ships the goods to the buyer and sends the shipping and title documents to a bank, which transmits the documents to the buyer's bank. The buyer gains possession of the documents and thus ownership of the goods upon paying the bank or upon signing a draft agreeing to pay at a future date. Upon collection, the buyer's bank remits payment to the seller's bank.

Collection

Methods of __ include: -Send a duplicate invoice or a series of form letters -Call the customer or pay a visit -Suspend further shipment of goods until payment -Negotiate with the customer for payment If this doesn't work, then: -Report delinquent status to credit bureau -Reposessing collateral -Negotiating add'l corp or personal guarantees -Obtaining a lien on specific assets -Initiate direct legal action -Turn delinquent accounts over to a collection agency

Bilateral Netting

Purchases between two subsidiaries of the same company are netted against each other so that periodically, typically once or twice per month on preset dates, only the net difference is transferred. Requires a common (base) currency.

Capital

Refers to an individual or corporate customer's short- or long-term financial resources that could be accessed if the immediate cash flow is insufficient to meet payment obligations.

Internal Factoring

Similar to re-invoicing, however, rather than taking actual title to the goods, the unit buys AR from the exporting unit and collects funds from the importing unit.

Dynamic Discounting

Takes traditional trade discounts a step further and includes the ability to vary the discount according to the date of early payment; the earlier the payment, the larger the discount.

Credit Limit

The aggregate amount of credit granted to each customer.

Working Capital

The cash and other liquid assets required by any organization to continue its operations by satisfying both upcoming operational expenses and maturing short-term debt. To increase: collect cash flows, increase debt, sell assets/investments, or sell equity To reduce: use cash flows, repay debt, purchase assets/investments, pay dividends and buy back equity To increase this metric, a company would need to lengthen the PTP and shorten the OTC. = Current assets - Current Liabilities

Wait Time

The time lost while waiting for someone else to take action or the time needed to transmit information between two parties.

Debt Management Ratios (Coverage)

Times interest earned, long-term debt to capital, debt to total assets, and total liabilities to total assets ratios

Trade Credit Standards

Uses different information sources, the five C's of credit, and quantitative credit analysis. Stages include: (1) Establishing credit acceptance criteria that represents a maximum amount of payment risk the company is willing to assume, and (2) Deciding whether to approve a credit applicant under the criteria, and if approved, set a credit limit for that applicant.

Auto-Match Process

Validate invoices against purchase orders and receiving statements (referred to as a three-way match) to authorize payment of invoices. Customers who utilize this methodology often can have late payments if any discrepancies are identified.

Vouchering

Verify incoming invoices and authorize payments. Involves the traditional three-way match.