Chapter 15, Finance

promissory note

A document specifying the terms and conditions of a loan, including the amount, interest rate, and repayment schedule.

production; marketing; financial

Although inventory management is important, it is under the operational control of _____ managers and ______ people rather than _____ managers.

executive committee

Because of the importance of the policy, the firm's ___ ____ (which normally consists of the president in addition to the vice presidents of finance and marketing) has the final say on setting the credit policy

costly trade credit

Credit taken in excess of free trade credit, whose cost is equal to the discount lost.

asset-backed paper

It is generally unsecured, but "___ ____ ____" secured by credit card debt and other small, short-term loans has also been issued

current assets; net working capital; operating

It's important to understand working capital terminology and the basic definitions. Working capital is simply ______. _______is defined as current assets minus current liabilities. Net operating working capital (NOWC) is defined as current assets minus the difference between current liabilities and notes payable. NOWC represents working capital used for _______purposes.

trade credit

Liabilities that arise from purchases from suppliers made on credit.

conjunction

Marketable securities held for operations are managed in _____ with demand deposits—the management of one requires coordination with the other

lost; excessive; computer systems

Moreover, because errors in setting inventory levels lead to ____ sales or _____ carrying costs, inventory management is quite important. Therefore, firms use sophisticated ____ _____ to monitor their inventory holdings

shipping delays; sales slowdowns; customer delays in making payments

Moreover, the actual CCC would almost certainly differ from the theoretically forecasted value because of real-world complexities such as ____ _____, ____ ____, and ____ ____ ___ _____ _____

current liabilities; financing cost

NOWC differs from net working capital because interest-bearing notes payable are deducted from ____ _____in the calculation of NOWC. The reason for this distinction is that most analysts view interest-bearing notes payable as a ___ ___ (similar to long-term debt) that is not part of the company's operating free cash flows

bank loans

Non-financial companies also issue a great deal of paper, but they generally rely more heavily on ____ _____for short-term funding

lower

Notably, many companies were holding cash overseas in markets with ____ corporate tax rates

operating short-term securities; other short-term securities

Note that a firm's marketable security holdings can be divided into two categories:

legal obligation; commitment

Note that a revolving credit agreement is similar to an informal line of credit, but with an important difference: The bank has a ____ _____ to honor a revolving credit agreement, and it receives a ____ fee.

technologies

Note that changing ______can lead to changes in the optimal policy

high; loses

Note that when standards are set too low, bad debt losses will be too _____; on the other hand, when standards are set too high, the firm _____ sales and thus profits.

faster

Note too that short-term loans can generally be negotiated much ______than long-term loans

credit scores

Numerical scores that indicate the likelihood that people or businesses will pay on time.

low; quickly

On the plus side, many retail companies benefit from a _____ DSO because most of their customers pay with cash or credit cards that are ______ collected

collection policy

The company's____ ____ is how the company handles its credit accounts.

current assets financing policy

The manner in which current assets are financed.

amount; maturity; interest rate; interest only versus amortized; frequency of interest payments; discount interest; add-on loans; collateral; restrictive covenants; loan guarantees

The terms of a bank loan are spelled out in a promissory note. Here are some key features of most promissory note

reduced

When the firm holds marketable securities, the need for demand deposits is ______

credit period; discounts; credit standards; collection policy

credit policy consists of four variables:

increase

many argue that growing concerns about banks' willingness to provide credit has caused some companies to ______ their holdings of cash and marketable securities

speeds up collections; increases free cash flows; reduces required cash holdings

requiring customers to pay via wire deposits ____ ___ ____, ___ ___ ____, and ___ ___ ___ ___

flexibility

short-term debt may offer greater _______

credit policy; CFO

the firm's ______ is the primary determinant of accounts receivable, and it is under the administrative control of the ___.

higher

the more frequently interest is paid, the ______ the effective rate.

highest; equalize; equilibrium

Finally, larger corporations shop for securities all around the world, buying wherever risk-adjusted rates are _______. This shopping tends to ______ worldwide rates—if interest rates in Europe are higher than rates in the United States for equally risky securities, companies will buy European securities, driving their prices up and their yields down, until an ______ has been established

protect the lender; fewer

Finally, long-term loan agreements generally contain provisions, or covenants, that constrain the firm's future actions in order to ____ ___ ____, whereas short-term credit agreements generally have ____ restrictions

free; costly

Firms should always use the ___ component, but they should use the ____ component only if they cannot obtain funds at a lower cost from another source

The CFO should push salespeople to speed up sales and the credit manager to accelerate collections. Also, the purchasing department should try to get longer payment terms.

What should be done if the CCC if too high?

short-term; highly aggressive; extremely non-conservative

the dashed line in panel b could have been drawn below the line designating fixed assets, indicating that all of the current assets—both permanent and temporary—and part of the fixed assets were financed with _____ _____ credit. This policy would be a _____ _____, ____ ______ position, and the firm would be subject to dangers from loan renewal as well as problems with rising interest rates

average cash balances

utilities, oil companies, department stores, and the like generally use "billing cycles" under which different customers are billed on different days, causing cash to flow in evenly during the month. These firms can then set up their own payment schedules to match their inflows. This reduces ___ ___ ___, just as your personal average monthly balance can be reduced when your income comes in at the same time as your required payments.

higher; better; position; performance

Two professors, Hyun-Han Shin and Luc Soenen, studied more than 2,900 companies over a 20-year period. They found that shortening the cash conversion cycle resulted in higher _____ and ____ stock price performances. Their study demonstrates that good working capital management is important to a firm's financial _____ and _____

commercial paper

Unsecured, short-term promissory notes issued by large firms in denominations of $100,000 or more.

commercial paper

Unsecured, short-term promissory notes of large firms, usually issued in denominations of $100,000 or more with an interest rate somewhat below the prime rate.

inventory-to-sales

Therefore, the CFO will compare the firm's ___ __ ___ ratio with those of its benchmarks to see if things look "reasonable."

safety stocks

This process lowers the "_____ _____" that would otherwise be necessary to avoid running out of stock, which lowers inventories to profit-maximizing levels.

seasonal; cyclical

To begin, note that most businesses experience ______ and/or ______ fluctuations

Robinson-Patman Act

. Under the _____ ____ ___, it is illegal for a firm to charge prices that discriminate between customers unless the different prices are cost-justified. The same holds true for credit—it is illegal to offer more favorable credit terms to one customer or class of customers than to another unless the differences are cost-justified

free; costly

Trade credit has a portion that is ______ if the payment occurs during the discount period. If the firm does not take the discount then the trade credit is ______

relaxed; restricted; can

. A ________investment policy means that relatively large amounts of cash, marketable securities, and inventories are carried, and a liberal credit policy results in a high level of receivables. A ________ investment policy means that the holdings of cash, marketable securities, inventories, and receivables are constrained. A moderate investment policy is an investment policy that lies between the two extremes. Changing technologies ___ lead to changes in the optimal working capital investment policy.

The loan officer should offer the company an add-on interest loan because there is a high risk that the company will not be able to repay the principal on the loan at the end of the project's life.

A bank loan officer has been approached by a start-up company that needs a five-year loan to purchase the equipment for its first project. The project will have a life of five years. At the end of five years, the equipment will be worthless. The founders of the company told the loan officer that they would be willing to pay a much higher interest rate on a simple interest loan rather than contracting to an add-on interest loan.

maturity matching, or "self-liquidating," approach

A financing policy that matches the maturities of assets and liabilities. This is a moderate policy.

relationship

A firm's relationship with its bank—especially its ability to borrow on short notice—can have a significant effect on its need for both demand deposits and marketable securities.

revolving credit agreement

A formal, committed line of credit extended by a bank or other lending institution.

secured loans

A loan backed by collateral, often inventories or accounts receivable.

prime rate

A published interest rate charged by commercial banks to large, strong borrowers.

low; high; work stoppages; unhappy customers;

A restricted (lean-and-mean) policy indicates a ___ level of assets (hence, a high total assets turnover ratio), which results in a ____ ROE, other things held constant. However, this policy also exposes the firm to risks because shortages can lead to ____ _____, _____ ______, and serious long-run problems

credit policy

A set of rules that include the firm's credit period, discounts, credit standards, and collection procedures offered.

cash budget

A table that shows cash receipts, disbursements, and balances over some period.

simple; simple

A(n) ________ interest loan is one where interest only is paid monthly. The ______ interest rate per day is the nominal interest rate divided by the number of days in the year.

There is uncertainty about the lives of assets.; Some common equity must be used, and common equity has no maturity.

Actually, two factors prevent an exact maturity matching:

short-term

Although banks do make longer-term loans, the bulk of their lending is on a ______ basis

line of credit

An arrangement in which a bank agrees to lend up to a specified maximum amount of funds during a designated period.

moderate investment policy

An investment policy that is between the relaxed and restricted policies.

retailing; more

As you would expect, the CCC tends to be higher in _____ industries that require ____ inventory.

upward sloping; lower than

Because the yield curve is normally _______ __, the cost of short-term debt is generally ______ _____ the cost of long-term debt. However, short-term debt is riskier to the borrowing firm for two reasons

If a firm borrows on a long-term basis, its interest costs will be relatively stable over time. If a firm borrows heavily on a short-term basis, a temporary recession may adversely affect its financial ratios and render it unable to repay this debt.

Because the yield curve is normally upward sloping, the cost of short-term debt is generally lower than that of long-term debt. However, short-term debt is riskier to the borrowing firm for two reasons:

Inventory and accounts payable are carried at cost on the balance sheet, whereas accounts receivable are recorded at the price at which goods are sold.

Both the inventory conversion period and payables deferral period use the average daily COGS in their denominators, whereas the average collection period uses average daily sales in its denominator. Why do these measures use different inputs?

100,000

Commercial paper is sold primarily to other business firms, insurance companies, pension funds, money market mutual funds, and banks, in denominations of at least $______

informed judgment

Computerized analytical systems assist in making better credit decisions, but in the final analysis, most credit decisions are exercises in _____ ____

accruals

Continually recurring short-term liabilities, especially accrued wages and accrued taxes.

It has a major effect on sales; It influences the amount of funds tied up in receivables.; It affects bad debt losses.

Credit policy is important for three main reasons:

free trade credit

Credit received during the discount period.

subjective

Credit standards and collection policies are relatively ______, so they are not generally discussed in the published credit terms

permanent current assets

Current assets that a firm must carry even at the trough of its cycles.

temporary current assets

Current assets that fluctuate with seasonal or cyclical variations in sales.

stimulate; lengthens; receivables; default

Customers prefer longer credit periods, so lengthening the period will ____ sales. However, a longer credit period ____ the cash conversion cycle; hence, it ties up more capital in _____, which is costly. Also, the longer a receivable is outstanding, the higher the probability that the customer will ____ and that the account will end up as a bad debt

trade credit

Debt arising from credit sales and recorded as an account receivable by the seller and as an account payable by the buyer.

transactions

Demand (or checking) deposits are far more important than currency for most businesses. These deposits are used for _______—paying for labor and raw materials, purchasing fixed assets, paying taxes, servicing debt, paying dividends, and so forth

small

Each firm decides its own optimal level, but even for retailers, currency generally represents a _____ part of total cash holdings

capital budgeting; capital; weakness; ratios

First, it is expensive to install and maintain the computer systems used to track inventories, and the ____ _____ analysis discussed earlier in the text must be used to determine which system is best. Second, if the firm decides to increase its inventory holdings, the financial manager must raise the _____ needed to acquire the additional inventory. And third, the financial manager is responsible for identifying any area of _____ that affects the firm's overall profitability, using _____ and other procedures for comparing the firm to its benchmark companies.

accounts receivable

Funds due from a customer.

spontaneous funds

Funds that are generated spontaneously as the firm expands.

size; importance

Given the _____ and _____ of marketable securities holdings, how they are managed can have a significant effect on profits

liquidity; balance sheet; operating; other

Highly profitable firms such as Microsoft often hold far more securities than are needed for _____ purposes. Those securities will eventually be liquidated, and the cash will be used for such things as paying a large one-time dividend, repurchasing stock, retiring debt, acquiring other firms, or financing major expansions. This breakdown is not reported on the ____ _____, but financial managers know how much of their securities will be needed for _____ versus ______ purposes.

no; minimize

However, commercial demand deposits typically earn __ interest, so firms try to ____ their holdings while still ensuring that they are able to pay suppliers promptly, take trade discounts, and take advantage of bargain purchases

timing; law

However, firms cannot control their accruals because the _____ of wage payments is set by contract or industry custom and tax payments are set by _____

collateral

However, firms may find that they can borrow only if they put up _____ to protect the lender or that securing the loan enables them to borrow at a lower rate

carrying; more

However, if it is possible to sell on credit and to impose a ____ charge on the receivables that are outstanding, credit sales can actually be ____ profitable than cash sales

cash conversion cycle

If a firm can sell goods faster, collect receivables faster, or defer its payable longer without hurting sales or increasing operating costs, its _________ _______ ______ would decline, its interest expense would be reduced, and its profits and stock price would be improved

reduce

If a firm can synchronize its cash inflows and outflows, the firm will _____ its need for cash balances

Accounts Receivable

If either sales or the collection period changes, so will accounts receivable.

add-on interest

Interest that is calculated and added to funds received to determine the face amount of an installment loan.

supplies; raw materials; work in process; finished goods

Inventories, which can include: ____, _____ ____, ___ __ ___, and ___ ____ are an essential part of virtually all business operations.

bank loans; credit from suppliers; accrued liabilities; long-term debt; common equity

Investments in current assets must be financed, and the primary sources of funds include_____ ____, ____ ____ _____, ____ _____ ____, and ____ ___

decline; rise; decline; worse; suitable

Long-term Treasury bonds are safe, but they are not well suited for the marketable securities portfolio because their prices _____ when interest rates rise. Similarly, short-term securities issued by risky companies are not suitable because their prices _____ when the issuers' problems grow ____. Treasury bills, most commercial paper (discussed in Section 15-11), bank certificates of deposit, and money market funds are ______ holdings

First, the discount amounts to a price reduction, which stimulates sales. Second, discounts encourage customers to pay earlier than they otherwise would, which shortens the cash conversion cycle

Offering discounts has two benefits.

inventory conversion period

The _______ ___ ___ is the average time required to convert raw materials into finished goods and then to sell them.

short-term; long-term

Optimistic and/or aggressive managers will probably lean more toward ____ ____ credit to gain an interest cost advantage, while more conservative managers will lean toward ____ ____ financing to avoid potential loan renewal problems

long-term; marketable securities; short-term; security holdings; very safe; conservative

Panel c of the figure shows the dashed line above the line designating permanent current assets, indicating that ______ capital is used to finance all the permanent assets and to meet some of the seasonal needs. In this situation, the firm uses a small amount of short-term credit to meet its peak requirements, but it also meets part of its seasonal needs by "storing liquidity" in the form of ________. The humps above the dashed line represent _____ financings, while the troughs below the dashed line represent short-term security holdings. This is a ____ ____, ______ financing policy.

lockboxes

Post office boxes operated by a bank to which payments are sent. Used to speed up effective receipt of cash.

discounts

Price reductions given for early payment.

The CFO is not taking into account the amount of time the company has to pay its suppliers. Generally, there is a certain length of time between the purchase of materials and labor and the payment of cash for them. The CFO can reduce the estimated length of the bank loan by this amount of time.

Purple Panda Importers's management plans to finance its operations with bank loans that will be repaid as soon as cash is available. The company's management expects that it will take 60 days to manufacture and sell its products and 50 days to receive payment from its customers. Purple Panda's CFO has told the rest of the management team that they should expect the length of the bank loans to be approximately 110 days. Which of the following responses to the CFO's statement is most accurate?

relaxed reinvestment policy

Relatively large amounts of cash, marketable securities, and inventories are carried, and a liberal credit policy results in a high level of receivables.

increases

Securities pay interest, whereas demand deposits do not, so holding securities in lieu of demand deposits _____ profits

This statement is true and an advantage of short-term financing.

Short-term loans usually have a lower cost than long-term loans. Identify whether the preceding statement is true or false.

credit terms

Statement of the credit period and discount policy.

moderate current assets financing policy

Still, when a firm attempts to match asset and liability maturities, this is defined as a _____ _____ ____ ____ ____

conservative approach

Suppose a firm occasionally faces demand for short-term credit but usually has an excess of short-term capital to finance current assets. Which approach is the firm following?

aggressive approach

Suppose a firm wants to take advantage of an upward-sloping yield curve. If the firm believes that interest rates will stay constant and it wants to use the current yield curve to bolster profits, which approach should the firm follow?

average collection period

The ___ ___ ____ is also known as the days' sales outstanding. It is the average length of time required to convert the firm's receivables into cash, that is, to collect cash following a sale

effective interest rate

The ____ _____ ____ on a loan depends on how frequently interest must be paid

better; lessens; cash budget

The _____ the firm can forecast its cash inflows and outflows, the smaller its needs for funds to meet unexpected requirements. Therefore, improving inflow/outflow forecasts ____ the need to hold liquid assets and thus reduces the required amount of working capital. The ____ _____ is the key tool used to improve cash forecasts.

maturity matching; moderate; aggressive; conservative; marketable

The _______ _______ , or "self-liquidating," approach is a financing policy that corresponds with the maturities of assets and liabilities. This represents a(n) __________financing policy. A(n) ____ financing policy is one in which a firm finances some of its permanent assets with short-term debt. A(n) __________ financing approach means that a firm uses long-term capital to finance all permanent current assets and to meet some of the seasonal needs. With this approach the firm will use a small amount of short-term credit to meet its peak requirements, but it also meets part of its seasonal needs by storing liquidity in the form of __________ securities.

cash conversion cycle

The _________ __ __ is the length of time funds are tied up in working capital, or the length of time between paying for working capital and collecting cash from the sale of the working capital.

credit terms

The company's ____ _____ are the conditions of the credit sale, including cash discounts and due dates.

target cash balance

The desired cash balance that a firm plans to maintain in order to conduct business.

reduction; rapidly

The discount specifies what the percentage _____ is and how ____ payment must be made to be eligible for the discount.

preferences; judgments

The factors discussed here should be considered, but the final decision will reflect managers' personal _______ and ______.

credit standards

The financial strength customers must exhibit to qualify for credit.

restricted

The firm's beta coefficient if it has no debt.

Hold marketable securities rather than demand deposits to provide liquidity.Borrow on short notice. Forecast payments and receipts better. Speed up payments. Use credit cards, debit cards, wire transfers, and direct deposits. Synchronize cash flows

The following techniques are used to optimize demand deposit holdings

nominal; higher

The indicated rate is a _____ rate, and the effective annual rate is generally _____

credit period

The length of time customers have to pay for purchases.

cash conversion cycle

The length of time funds are tied up in working capital, or the length of time between paying for working capital and collecting cash from the sale of the working capital.

credit standards

The minimum financial strength a customer must have to be granted credit is indicated by the company's ____ ____

annual planning; cash flows; payments

The monthly budget is good for _____ ______, while the daily budget gives a more precise picture of the actual ____ ____ and is good for scheduling actual _____ on a day-by-day basis

sales

The monthly cash budget begins with a _____ forecast for each month and a projection of when actual collections will occur. T

sales; collections; materials; net cash gain or loss; borrowed; invested

The monthly cash budget begins with a _____ forecast for each month and a projection of when actual collections will occur. Then there is a forecast of ______ purchases, followed by forecasted payments for materials, labor, leases, new equipment, taxes, and other expenses. When the forecasted payments are subtracted from the forecasted collections, the result is the expected ___ ___ ___ __ ___ for each month. This gain or loss is added to or subtracted from the beginning cash balance, and the result is the amount of cash the firm would have on hand at the end of the month if it neither ____ nor _____

long-run earnings; intrinsic value

The optimal strategy is the one that maximizes the firm's _____ ____ and the stock's _____ _____.

cash budget

The primary tool used is the ___ __ __ , which is a table that shows cash receipts, disbursements, and balances over some time period.

upward sloping; lower

The reason for adopting the aggressive policy is to take advantage of the fact that the yield curve is generally ____ ____; hence, short-term rates are generally _____ than long-term rates

vary

The relative benefits of short-term debt and long-term debt are likely to ____ over time

low; lowers

The relaxed policy minimizes such operating problems, but it results in a ___ turnover, which in turn _______ ROE

regular, or simple, interest loan

The situation when interest only is paid monthly.

cash, marketable securities, receivables and inventories

The top line has the steepest slope, which indicates that the firm holds a great deal of ______, _____ _____, ______ and ______ relative to its sales

credit sales; sales; collections

The total amount of accounts receivable outstanding at any given time is determined by the volume of ____ ____ and the average length of time between _____ and ______

accounts receivable; inventories

Therefore, most secured short-term business loans use ____ _____ and _____ as collateral

currency; demand; marketable; cash equivalents

When most people use the term cash, they mean ____(paper money and coins) in addition to bank demand deposits. However, when corporate treasurers use the term, they often mean currency and _____ deposits in addition to very safe, highly liquid, ______ securities that can be sold quickly at a predictable price, and thus be converted to bank deposits. Therefore, "cash" as reported on balance sheets generally includes short-term securities, which are also called "______ _____."

UCC-1; UCC-1; same; seize

When the collateral securing a loan is to be kept on the borrower's premises, a form called a ____ is filed with the secretary of the state in which the collateral is located, along with a Security Agreement (also part of the Uniform Commercial Code) that describes the nature of the agreement. The _____ prevents the borrower from using the ____ collateral to secure loans from different lenders, and the security agreement spells out conditions under which the lender can ____ the collateral

low; plenty; low

When the economy is slack, loan demand is usually _____, inflation is ____, and the Fed makes plenty of money available to the system. As a result, rates on all types of loans are relatively ____.

depreciation expense

Which of the following items would not be included in the cash budget?

short-term debt

Which usually costs less—short-term or long-term debt?

coverage; credit history; credit score

With regard to credit standards, factors considered for business customers include ratios such as the customer's debt and interest _____ ratios, the customer's ____ ______ (whether the customer has paid on time in the past or tended to be delinquent), and the like. For individual customers, their ____ _____ as developed by credit rating agencies is the key item.

long-term; short-term

___ ____ loans always have a specific maturity date, while a ___ ___ loan may or may not have a specified maturity

optimal

______ inventory levels depend on sales, so sales must be forecasted before target inventories can be established

permanent; temporary

_________ current assets are those current assets that a firm must carry even at the trough of its cycles. __________ current assets are those current assets that fluctuate with seasonal or cyclical variations in sales.

risky

a strategy of financing long-term assets with short-term debt is really quite ____

operating short-term securities

are held primarily to provide liquidity and are bought and sold as needed to provide funds for operations,

other short-term securities

are holdings in excess of the amount needed to support normal operations

strong; restricts; high

conversely, when the economy is booming, loan demand is typically ____, the Fed ____ the money supply to fight inflation, and the result is ____ interest rates

nominal

f interest is paid once a year, the ____ rate also will be the effective rate.

true

t or f? accruals are considered spontaneous funds