F307 Quiz 1

Working Capital Management Tools

Multicurrency Accounts Netting (Bilateral and Multilateral) Leading and Lagging Re-invoicing Internal Factoring In-House Banking Export Financing

PV of Discount

NEGATIVE OR POSITIVE BASED ON YOUR POSITION (1000*(1-D) / (1 + (Cash Discount Period) * (OC/365))

Opportunity Costs Comparison

OC = (D/(1-D)) * (365/TD)

Check-based payments

Oldest non-cash payment instrument in US Primary regulation is UCC

PV of Full Payment

(1000*(1-D) / (1 + (Net Credit Period) * (OC/365))

Minimum Transfer

(Wire Cost-ACH Cost) / (Days Accelerated * (OC/365)

Advantages of Lockboxes

- Reduced processing float - Improved access to remittance information - Reduced information float - Reduced risk and improved security(pmts no longer received internally) - Improved control and record keeping capabilities - Uninterrupted service - Scalability - Proper segregation of duties

When should a Buyer Forgo an Offered Discount

-Buyer has no cash and cost of short-term borrowing greater than annualized discount rate -Buyer has cash, but short-term investment rates above annualized discount rate

Reasons to concentrate cash with ACH

-Can take a few days -Inexpensive or free -Can send and request payments -No human intervention -More secure

Types of Payments

-Cash Payments -Paper System -RTGS or Large Value Electronic -ACH or Small value electronic -Card based payments -Emerging Payments

Reasons to concentrate cash with wire transfers

-Instant -$10-$30 per transfer -Completed by bank workers -Less protection -Can only send payments

Typical collection process

-Invoice to customer -Customer Sends Payment and Remittance Advice -Vendor Receives and Processes Payment -Funds deposited and cash applied

Inventory Management Techniques

-JIT: Just in time inventory -MPS: Material planning system -Supplier-managed replenished programs -Paid-on-production inventory process

Cash Discount Components

-Net Credit Period: Length of time the customer must pay -Cash Discount Period: Amount of time discount is available

Forms of Credit Extension

-Open Account -Installment Credit -Revolving Credit -Letter of Credit

Benefits of In-House Banking

-Reduction in banking costs -Aggregates many smaller transactions into fewer, larger transactions -Firmly solidifies treasury's role in the company -Potential for tax benefits through information and tax planning -Manages global treasury management solutions

AR Management

-includes billing and processing payments, monitoring payment patterns, and collecting delinquent accounts ◦Quickly convert A/R into cash while minimize Collection expense and bad Debt losses

Check Payment, Clearing, and Settlement Process

1. Payor (maker) sends check to payee 2. Payee separates check& remittance advice 3. Payee deposits check at depository bank 4. Bank images/encodes check and sends to clearing system 5. Clearing system delivers to drawee bank 6. Payor funds account by time of presentment 7. Value is transferred via settlement system 8. Payee receives available funds

Multicurrency Accounts Stipulations

1. The base currency in which the account is denominated 2. The portfolio of currencies accepted 3. The spread or margin over the spot rate to use in exchanging each currency back to the base currency 4. The value date to apply to debits and credits for each transaction type and currency

Cash Turnover

365/CCC

Credit Manager

A credit management function/position that 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.

Relaxed Current Asset Investment Strategy

A current asset management strategy in which a company maintains high levels of current assets relative to sales. A large investment in current assets is likely to lower investment returns, but the firm operates with less risk because of its larger liquid asset balances.

Restrictive current asset investment strategy

A current asset management strategy in which a company maintains low levels of current assets relative to sales. This strategy is typically the most profitable as long as unexpected events do not drive down liquidity to the point that it causes severe problems.

Payment Systems

A way to transfer value, usually involving a financial institution - cash, checks, cards, electronic payment systems. The combination of a payment instrument, a clearing channel and a settlement mechanism constitutes a payment system.

Cash Concentration Systems

ACH Payments, Wire Transfers, EFT

Collateral

Assets or guarantees to secure the loan

Types of payments based on who is paying who

B2B, C2B, G2B, etc

Participants in Credit Card Transaction

Cardholder: Company or individual Card Issuer: Bank that underwrites and issues credit cards Merchant: Where the card is used Merchant Acquirer: Bank that provides transaction services for merchant Acquiring Processor: 3rd party processor to manage daily settlement and info flows Issuer Processor: provides authorizations and risk management tools Network Operator: Maintain communication networks to support card activities

Uses of ACH Debits

Cash Concentration Consumer Payments Distributor Payments Utility Payments Tax Payments Corporate-to-Corporate Payments Check Conversions

Disbursement System

Centralized vs Decentralized

External Financing Requirements

Change in net working capital is the amount of new net financing needed

Five C's of Credit

Character, Capacity, Capital, Collateral, Conditions

Lockbox Processing Systems

Collection tool in which an FI or 3rd party vendor receives payments at specified post office box addresses, then processes the remittances and credits the payments into a payee's account.

Payment Card Industry Data Security Standards(PCI DSS)

Created by the card industry as a result of several system breaches and compromises of data. A couple security methods: ◦Digital certificates ◦Message authentication ◦Encryption

Capacity

Current and future financial resources that can pay obligations

Average Past Due

DSO-Average Days of Credit Terms

Investments in Receivables

Depends on amount of credit sales and DSO

Multicurrency Accounts

Deposit account where a customer can maintain balances in several currencies in one account

Float Neutral Calculation

Discount where you are indifferent between discount and not. D = 1 - (1)/(1 + TD * (OC/365))

Lockbox Cost Benefit Analysis

Find Average Dollar Days without lockbox by multiplying batches by calendar days and dividing by 30. Multiply that by OC to find Annual Cost of Float Now do the same with the lockbox numbers, add lockbox fees, eliminate internal fees, and see the net benefit.

Switching from Check to EFT

Float Neutral Calculation to find the discount where they are indifferent

Float

Float refers to the time interval, or delay, between the start and the completion of a specific phase or process occurring along the cash flow timeline Can result from -Wait time -Inefficiencies

Conditions

General economic environment and economic conditions for customer and seller

Export Financing

Governments often promote exports by helping companies finance their export activities Export loans, credit guarantees, or both

The Payment Process

Includes 4 elements: 1. Payment instructions: Info contained in transfer or check 2. Payment generation: Instructions are entered into the payment system itself 3. Clearing: Process where FIs use the payment information to transfer money between themselves 4. Settlement/Finality: Final step in the process when the beneficiary's bank account is credited and the payor's bank account is charged

Character

Intent or willingness to pay based on payment history

Merchant Card Fees

Interchange fees(referred to simply as interchange) §Largest portion of overall card fees §Debit fees are generally fixed §CC fees are both fixed and variable -§Assessments §Usually a percentage, set by network operators (Visa, MasterCard, etc.) -§Processor fee or markups §Sometimes referred to as transaction fees §Set by individual card processor §There are generally negotiable §Fees may be fixed and/or percentage based

Annualized Cost of Cash Discount

Interest Rate * (365/(30-10) Compare this to the Opportunity Cost that is either given or calculated. If you're the buyer, and the OC is lower, than you take the discount.

Conservative Policy

Long-term sources cover everything except for a portion of fluctuating current assets

Maturity Matching

Long-term sources of financing cover fixed assets and permanent current assets while short term financing covers fluctuating current assets

Payor

Makes the payment

DSO

Outstanding AR / Avg Daily Credit Sales

Other Paper-Based Instruments

Payable Through Draft (PTD) Remotely Created Check (RCC) Money Order Traveler's Check Sight Draft/Time Draft Cashier's Check/Certified Check Government Warrant

Key Participants in Payment Clearing Process

Paying Bank Depository (Receiving) Bank Correspondent Bank Central Bank or Monetary/Banking Authority Bank Clearinghouse Third-Party Clearing Entity

Primary Parties of Payment Systems

Payor and Payee

Other two parties in a payment system

Payor's and payee's banks

Uses of ACH Credits

Payroll Direct Deposit Government Transfer Payments Dividend Payments Corporate-to-Corporate Payments

Problems in "Managing CCC Components"

Potential lost sales Production stoppages Stretched payables Foregone cost-saving trade discounts Higher prices assessed by vendors on smaller orders or slow payments Refusal to sell to weak customers Excessive reliance on A/P rather than S/T bank credit

Key event of Check Clearing

Presentment

Export Credit Agencies

Public agencies and entities that provide government-backed loan guarantees and insurance to corporations from their home country that seek to do business overseas in developing countries and emerging markets

Payee or Beneficiary

Receives the payment

Capital

Short and long-term financial resources to supplement insufficient cash flow for payments

Three-way match

The activity within the procurement process that ensures that the data on the invoice matches the data on the purchase order and the goods receipt.

Eximbank

The export credit agency of the U.S. which guarantees working capital loans for U.S. exporters, guarantees the repayment of loans, makes loans to foreign purchasers of U.S. goods and services, and provides credit insurance protecting U.S. exporters.

Re-invoicing

The policy of buying goods from one unit, selling them to a second unit, and re-invoicing the sale to the next unit, to take advantage of favorable exchange rates

Cash Conversion Cycle

The ratio that reflects the number of days between a company paying for raw materials and receiving cash from selling the products made from those raw materials Days Inventory + Days Receivable - Days Payable Purchase of Materials to Payment of Materials to Sale of Product to Collecting AR

Credit Period

Time period that can pass before a customer's payment is due. Usually between 30 and 120 days

Key Factor In Settlement Process

Timing of clearing vs settlement of payment

Aggressive Policy

Use short term financing for all fluctuating current assets and for a portion of permanent current assets

For seller

You want to have the greatest PV. You want your discount to be less than the float neutral. You want your interest to be less than the cost of the cash discount

Zero Balance Accounts

a disbursement account in which the firm maintains a zero balance, transferring funds in from a master account only as needed to cover checks presented for payment

AR Aging Schedule

a report listing customer account balances by length of time outstanding

Common Terms of Sale

cash before delivery (CBD), cash on delivery (COD), cash terms, net terms, discount terms, monthly billing, draft/bill of lading, seasonal dating, consignment

Operating Cycle Formula

inventory period + accounts receivable period

AP Manager

primary responsibility is to verify incoming invoices and authorize payments -sometimes referred to as "vouchering"

Operating Cycle

the period between the acquisition of inventory and the collection of cash from receivables

Accounts Payable Period

the time between receipt of inventory and payment for it

Accounts Receivable Period

the time between sale of inventory and collection of the receivable

Inventory Period

the time it takes to acquire and sell inventory

Large Value Electronic Funds Transfer(EFT)/Wire Transfer Systems

§Real-Time Gross Settlement(RTGS) System§Clearing House Interbank Payments System(CHIPS) §TARGET2 and the Single Euro Payments Area (SEPA) §Continuous Linked Settlement(CLS) §Society for Worldwide Interbank Financial Telecommunication(SWIFT)

Disbursement Management Products

• Demand Deposit Accounts (DDAs) • Zero Balance Accounts(ZBAs) • Imprest Accounts • Controlled Disbursement

Electronic Disbursement Products

• Direct Deposit (ACH) Payments----Electrical Fund Transfer(EFT) • Wire Transfers

Controlled Disbursement

• Provides notification of checks that will clear account that day • Offered in conjunction with Fed Payor Bank Services • Often combined with a ZBA • Managing discrepancies after notification

Benefits of a Netting System

◦A reduction in the number of FX transactions and cross-border wire transfers, and benefits from natural hedging ◦More favorable FX rates due to the potential for larger FX trades resulting from consolidation ◦Improved cash and currency exposure forecasting for both the subsidiary and the parent company as a result of the ability to preplan cross-border payments

Check-clearing process

◦Begins with the deposit of a check drawn on a U.S. bank in USD into a payee's account ◦The payee's bank is called the bank of first deposit (or depository bank) ◦This bank must encode the check amount and start the check clearing process ◦Today, as a result of Check21, the deposited check is usually scanned at the depository bank and clearing is primarily image-based

Settlement Process Methods

◦Bilateral exchange of value ◦Correspondent bank accounts ◦Reserve accounts at a central monetary or banking authority

Transit Check Clearing

◦Clearinghouse ◦Correspondent bank ◦Direct send or direct exchange ◦Federal Reserve System (Fed)

What if cash is normal method of payment

◦Concerns include: payment security/integrity, fraud, cost of managing payments

Credit Cards

◦Credit card transaction participants ◦Lifecycle of a credit card transaction ◦Pmt card industry data security standards (PCI DSS) ◦Merchant card fees ◦Open Loop (Bank Issued) ◦Closed Loop (Gas, Retailer) ◦EMV Chip cards

To ensure consistent application and fairness, companies should maintain written credit policies and procedures that clearly define their:

◦Credit standards ◦Credit terms ◦Customer discounts ◦Methods of monitoring financial distress ◦Collection policies

Global paper-based payment systems involve the clearing and settlement of checks or drafts within and between countries

◦Cross-border check clearing is often a slow, complicated and expensive process ◦Checks and drafts are typically collection items settled through correspondent banks

Advantages of ECAs

◦Lower interest rates, usually fixed ◦Government involvement may offer some protection against foreign government appropriation or interference

Image-Based Clearing

◦Many checks now clear same day, with remainder settling in one day ◦Finality may be delayed due to returned items

Other types of payment cards

◦Purchasing cards ◦Travel & Entertainment (T&E) cards ◦Fleet Cards ◦Ghost Cards or Virtual Cards ◦Departmental (Unnamed) ◦Single-use cards ◦Stored-value cards (SVC) ◦Chip Cards or Smart cards

Costs of a Netting System

◦Setup, administration and maintenance expenses

Debit Cards (EFTPOS)

◦Signature-based vs. PIN-based

Disadvantages of ECAs

◦Time required to get necessary approvals ◦Currency exposure if the currency of the loan in different from that of the cashflows from the project being financed

Inventory Financing Alternatives

◦Trade credit often finances a significant portion of inventory ◦Supply chain financing ◦Collateralized loans (asset-based lending) ◦Use of public or field warehouse to store inventory ◦Floor planning for high-value durable goods