ACF - Net Working Capital
Current Assets
Include cash, marketable securities, accounts receivable, inventory, prepaid expenses - can be converted into cash within 1 year - usually listed on the balance sheet in descending order of liquidity
A firms credit standards
Credit score > 75: extend standard credit - 65 < or = credit score < or = 75: extend limited credit - credit score < 65: reject application
5. CCC =
OC - APP
3. APP =
average accounts payable / daily COGS
2. ACP =
average accounts receivable / daily sales
1. AAI -
average inventory / daily COGS
AR management - setting credit standards
credit standards are those that customer must meet in order to obtain credit - starting with the highest level of credit standards. lower it until the marginal benefit of higher sales = the marginal cost of higher financing, administrative and bad debt expenses
Working Capital =
current assets
Net Working Capital =
current assets - current liabilities
Current Ratio (Working Capital Ratio) =
current assets / current liabilities - measures a firm's ability to pay off its current liabilities with its current assets - a ratio of < 1 may indicate liquidity problems in the near future - problems with the current ratio as a measure of liquidity (1) current assets vs. quick assets (2) low cash vs. line of credit (3) high accounts receivable vs. long average collection period
2 common measures of liquidity
current ratio and quick ratio
Current Liabilities
include accounts payable notes payable, and accrued expenses (taxes, wages, etc.)
When is the current account balance at its optimal? (what equals what)
marginal carrying cost = marginal shortage cost
Average Collection Period (ACP)
monitor that it does not significantly exceed the credit period
Payment Pattern
monitor that there is not a significant drop in the usual percentage of sales collected in the month of the sale and in each month after
Age schedule of receivables
monitor that there is not a significant increase in the fraction of "high age group" receivables to total receivables
Carrying a smaller balance of an inventory item means a smaller total carrying cost but also what?
smaller production runs -> more frequent production runs -> higher total setup costs (cost tradeoff #1) - smaller quantities of the inventory item ordered each time -> more frequency placement of orders -> higher total order cost (cost tradeoff #2)
Operating Cycle (OC)
time between the purchase of raw materials and the receipt of cash from from the sale of finished goods - measures the efficiency of current assets management
Average Collection Period (ACP)
time between the sale of finished goods and the receipt of cash
Credit Scores
uses statistically-derived weights for key credit characteristics to predict whether a credit applicant will default - used for high volume low credit requests, by large credit card operations (e.g., banks, oil companies, department stores)
When do you increase the account balance by a dollar? (what is less that what)
when marginal carrying cost < marginal shortage cost
2 measures for the efficiency of working capital management
Operating Cycle (OC) and Cash Conversion Cycle (CCC)
Setting credit terms involves decision over what? (3)
(1) credit period, which specified when the cash payment is due (2) cash discount, which specifies the amount of discount given if the cash payment is made within the discount period (3) discount period, which specified the time period within which the cash discount is available
If a firm decides to extend credit to customers, it must (4)
(1) set credit standards (2) set credit terms (3) develop collection policy (4) monitor daily at the individual and aggregate levels
Quick Ratio (Asset Test Ratio) =
(cash + marketable securities + accounts receivable) / current liabilities - measures a firm's ability to pay off its current liabilities with its quick assets, which exclude inventories, supplies, prepaid expenses - not a perfect measure of liquidity as it overcomes only the first problem listed above
4. OC =
AAI + ACP
OC =
AAI + ACP and APP + CCC
Monitoring credit (3 techniques)
Average collection period (ACP), age schedule of receivables, and payment pattern
The 5 C's
Character (record of and attitude toward meeting debt obligations) - Capacity (ability to repay based on current income) - Capital (financial strength as reflected by wealth) - Collateral - Conditions (economy-wide, industry-specific, firm-specific, customer-specific) ----- a framework for in-depth credit analysis and used for high value credit requests
When do you decrease the account balance by a dollar? (what is greater than what)
carrying cost > shortage cost
What balance to maintain for a CA or CL account involves trading off what 2 costs?
carrying cost and shortage cost
Economic Order Quantity (EOQ)
gives the optimal number of units of an inventory item to order each time
Carrying Cost
the cost of carrying the current account balance - the higher the current account cost, the higher the marginal carrying cost
Shortage Cost
the cost of reducing the account balance - the higher the current account balance, the lower the marginal shortage cost
Working Capital Management
the management of current assets and current liabilities to ensure smooth day-to-day operations
When should firms place another order?
the reorder point for a firm depends on shipment duration and safety stock
Average Age of Inventory (AAI)
time between purchase of raw materials and the sale of finished goods
Cash Conversion Cycle (CCC)
time between the payment of cash for the purchase of raw materials to the receipt of cash from the sale of the finished goods - measures the overall efficiency of both current assets management and current liabilities management
Average Payment Period (APP)
time between the purchase of raw materials and the payment in cash
How to get a short CCC
turn over inventory as quickly as possible, without interrupting production - collect accounts receivable as quickly as possible, without losing sales - pay accounts as slowly as possible, without damaging credit ratings or incur late fees
