Chapter 12
(1) Total cost =
(Average Inventory)(Carrying costs per unit)+ (Reordering cost per order)(number of orders)
Total Carrying Cost =
(Average Inventory)(Carrying costs per unit).
Nominal rate for terms of sale =
(Discount/ 1-discount) * (365/Discount Period)
to compare the discount rate on factoring with other options for financing, the discount must be converted into an annual interest rate: Nominal interest rate =
(Discount/ 1-discount) *(receivables turnover)
Minimum carrying costs =
(EOQ/2)* C
(2) Total cost =
(Order size / 2) * (Carrying costs per unit)+(Reordering cost per order)(Unit sales per period/ Order size)
Total Reordering costs =
(Reordering cost per order)(number of orders).
The average value for any period can be computed as =
(Start value+Ending value) / 2
Formal line of credit
(a legal commitment by the bank, often described as "committed")
Informal line of credit
(often called "uncommitted").
Reasons for holding cash
-Speculative Motive -Precautionary Motive -Transaction Motive
Sales percentage collected in the current period
1-(accounts receivable period/number of days in period)
Accounts Payable Period =
365/Accounts Payable Turnover
Receivables Period =
365/Receivables Turnover
Inventory Period =
365/inventory Turnover Ratio
(2) Cash Cycle =
= Inventory Period + Accounts Receivable Period - Account Payable Period
Credit score or credit rating
A quantitative assessment of a customer's creditworthiness generated from these information sources
A revolving line of credit
A revolving credit arrangement If a line of credit is regularly renewed by the bank for multi-year periods
Working Capital Management
A set of policies intended to help a company operate efficiently by monitoring and using its current assets and liabilities optimally. T
Assigning accounts receivables
Also known as accounts receivables financing Means that a firm uses receivables as collateral for a secured short-term loan.
Float =
Available balance - book balance.
Accounts Payable Turnover =
COGS/(Average) Accounts Payable
Inventory Turnover =
COGS/Average Inventory (Inventory)
The term liquidity
Can refer to how quickly and easily a firm can raise cash.
Just-in-time (JIT) inventory
Common among Japanese manufacturer Inventory system in which companies manufacture or purchase goods just in time for use.
Receivables Turnover =
Credit Sales / Accounts Receivable
The EOQ model
Derives the optimal amount of inventory to order in order to minimize total costs.
Terms of sale=
Discount / Discount Period, net full period
Optimal average inventory level =
EOQ/2
Defaul
Failure to make payments on debt, can trigger a firm's bankruptcy
Precautionary motive
Firrms maintain liquidity in order to avoid the costs associated with running out of cash or other current assets.
When a firm invests its short-term cash surpluses, there are several factors that should be considered.
First, the investment should give a higher return than if the money is just left as cash. Second, the investment must be very liquid, so that it can be converted back to cash at short notice. Third, the investment should be safe.
Stock-out
If a firm runs out of inventory and loses sales
Operating Cycle =
Inventory Period + Accounts Receivable Period.
Cash-out
It a firm run out of cash and has to sell assets, borrow, or default
A conservative, or flexible, policy
Means that the firm has high liquidity by holding high levels of cash, lots of inventory, and being generous in extending credit to customers.
Transaction motive
Motivation for a firm to hold cash is to meet its day-to-day operating needs
(1) Cash Cycle =
Operating Cycle - Accounts Payable Period
Average inventory =
Order size / 2
Economic Order Quantity (EOQ) =
SQRT (2RU/C) R = the reordering cost C = carrying cost per unit U = unit sales per period
(1) Sales collected in future periods = ending accounts receivable balance =
Sales - Sales collected in the current period
Commercial Paper
Some large firms bypass banks for their short-term borrowing needs and go directly to investors in the capital markets. These firms issue short-term unsecured bonds
Book balance or ledger balance
The amount of cash shown in a company's record
Available balance or the collected balance
The amount that the bank records as being available
The net cash flows each period
The cash collections - the cash disbursements
The disadvantages include
The chance that some customers will not pay The lost time value of money The cost of monitoring and processing the credit.
The main shortage costs are
The costs involved in selling assets when the firm needs to raise cash, the costs involved in borrowing when the firm does not have enough cash, and the lost sales that may come from inadequate inventory or accounts receivable terms.
Collection Float
The delay between when a customer pays for a product (such as by writing a check) and when the firm actually has that money in its bank account Collection float is bad for the firm and is viewed as a negative dollar value
Float
The difference between the amount of cash in a company's records and the amount that is actually available at the bank
Factoring
The firm basically sells the accounts receivable to the lender (the lender is called the factor). The factor then collects the accounts receivable and takes any loss that comes from uncollected accounts receivable.
Disbursement float
The float that is generated by the delay in processing payments made by a firm Disbursement float is good for a firm and is viewed as a positive dollar value
Speculative motive
The motivation to hold cash in order to take advantage of unexpected opportunities Such as short-term projects, favorable interest rates, and favorable exchange rates
An aggressive, or restrictive, short-term financial policy
The opposite. Means to hold little cash, low levels of inventory, and to encourage customers to pay in cash.
Cash Budget
The overall plan for a firm's short-term cash levels
Cash management
The process of collecting and managing cash flows
Net Float =
The sum of disbursement float and collection float collection float + disbursement floa
A firm's credit policy typically has three components:
The terms of sale Credit analysis Collection policy.
Costs related to the lack of safety reserves
These are the lost sales and lost goodwill than occur when the firm does not have enough inventory or cannot extend credit to customers.
Trading and order costs
These are the transaction costs associated with having to raise cash (such as brokerage costs) or inventory (such as overtime for workers).
The main purpose of working capital management
To maintain sufficient cash flow so that a company can cover its short-term operating costs and short-term debt obligations.
The end goal of all credit policies is
To maximize shareholder value by facilitating revenues while minimizing the risk generated by extending credit.
Aging Schedule
To monitor accounts receivable, where all unpaid bills are classified according to the amount and the length of time that they are overduE
Shortage costs are often classified as arising from two sources:
Trading and order costs Costs related to the lack of safety reserves
Optimal orders per period =
U/EOQ
Number of orders =
Unit sales per period/ Order size
Conservative financial policies
Will increase the carrying costs for a firm
Effective rate for terms of sale =
[ (1 + (Discount/ 1-discount))^(365/Discount Period) ] -1
A financial manager can choose to pursue:
a conservative short-term financial policy or an aggressive policy
Cash disbursements divided into four categories:
accounts payable (materials and supplies), other operating expenses (wages, taxes, and other), capital expenditures (fixed assets), and financing costs (interest payments and dividends).
The accounting term for credit given to customers is
accounts receivable
(2) Sales collected in future periods = ending accounts receivable balance =
accounts receivable period/ number of days in period
A line of credit
allows for short-term unsecured loans up to some fixed amount and at some pre-arranged interest rate (the rate may be fixed relative to market interest rates such as LIBOR or the Fed Funds rate).
A cash budget is
an estimation of the cash flows of a business over a specific period of time intended to forecast any cash deficits that may occur so that the financial manager can prepare for them in advance.
Cash inflows
are referred to as cash collections and are not necessarily equal to the amount of sales each period
Carrying costs
are the costs associated with holding higher levels of current assets. Include things such as insurance and storage for inventory.
Cash flows can be classified as
arising from operations, capital spending, and changes in net working capital.
Cash Collections =
beginning accounts receivable + sales collected in current period.
A firm can generally raise cash in two ways:
by selling assets or by increasing liabilities and equity.
Total cost =
carrying cost + reordering costs
Credit analysis
concerns gathering information about customers and then analyzing that information in order to determine the creditworthiness of the customer.
A company's working capital is made up of its
current assets minus its current liabilities.
The optimal amount of current assets almost always fluctuates with
economic conditions, seasonal factors, and random events, so most firms will occasionally be faced with a surplus or a deficit of cash in some periods.
A firm's net collections and disbursements in a cash budget are helpful in
forecasting the transaction needs of a firm for cash
The cash budget should be analyzed alongside the
forecasts for cash inflows and disbursements in order to identify the trends in the firm's cash position
The line of credit may be
formal or informal
The terms of sale specify
how long the customer has until payment is due (called the credit period), the cash discount, and the type of credit instrument.
The operating cycle
is the time that it takes to produce inventory, to sell it, and to then collect this money from customers.
The advantage of offering credit is that
it can lead to increased sales
One of the main tasks of a financial manager is to
make sure that a firm has sufficient cash on hand to pays its bills as they come due
The credit instrument
refers to the type of legal or accounting document that is used to record the debt between the purchaser and the seller.
When a firm has excess cash due to a conservative policy,
some of the carrying costs can be offset by investing the cash in liquid securities, such as money market mutual funds or T-Bills.
The forecast of cash disbursements takes the
sum of cash outflows for accounts receivable, other operating expenses, capital expenditures, and financing expenses.
Shortage costs are
the costs that happen when a firm does not have enough current assets.
The items on a firm's financial statements can be used to measure
the inflows and outflows of cash each period.
Economic Order Quantity (EOQ)
the optimal order size to minimize the sum of ordering, carrying, and stockout costs
The accounts receivable period is
the time that it takes to collect money from customers after making a sale
The inventory period is
the time that it takes to produce and sell inventory.
When a firm faces a temporary cash deficit
they can minimize the shortage costs by preparing options for short-term borrowing.
Assigning and factoring accounts receivables are popular because
they provide off-balance sheet financing. The transaction normally does not appear in firm financial statements and a firm's customers may never know their accounts were assigned or factored.
The idea behind the cash budget is
to forecast cash inflow and cash outflows over the next couple periods.
The first step in preparing a cash budget is
to forecast the cash inflows
The effective rate is usually the more useful rate to compare
to other interest rates
Inventory management
unique to different firms and may include raw material, work-in-progress, and finished goods
The EOQ model helps managers decide
what is the optimal amount of inventory that needs to be ordered per operating cycle or production batch So a company does not have to make orders too frequently and there is not an excess of inventory sitting on hand.
One of the biggest problems for a firm is
when they fail to have enough cash on hand to make required payments
Aggressive financial policies
will minimize carrying costs, but may lead to shortage costs
Effective interest rate =
{ [ 1 + (Discount/ 1-discount) ] ^ receivables turnover }- 1