Final Exam

Cash Budget

A forecast of cash receipts and disbursements for the next planning period; helps the manager explore the need for short-term borrowing; the result is an estimate of cash surplus or deficit.

Line of Credit

A formal (committed) or informal (non-committed) prearranged, short-term bank loan.

Cash Flow Timeline

A graphical representation of the operating cycle and the cash cycle.

What is the net effect of a flexible short-term policy?

A relatively high level of net-working capital; a higher overall level of liquidity.

Accounts Receivable Financing

A secured short-term loan that involves either the assignment or factoring of receivables.

Inventory Loans

A secured short-term loan to purchase inventory.

Operating Cash Flow

Cash generated from a firm's normal business activities; EBIT plus depreciation less taxes.

Considerations to help analyze what is the most appropriate amount of short-term borrowing.

Cash reserves; maturity hedging; relative interest rates.

Variable Cost

Costs that change when the quantity of output changes.

Fixed Cost

Costs that do not change when the quantity of output changes during a particular period of time.

Shortage Cost

Costs that fall with increases in the level of investment in current assets; incurred when the investment in current assets is low; two kinds: trading/order and costs related to lack of safety reserves.

Carrying Cost

Costs that rise with increases in the level of investment in current assets; the larger the investment a firm makes in its current assets, the higher this will be; opportunity costs associated with current assets.

DOL

Degree of operating leverage; the percentage change in operating cash flow relative to the percentage change in quantity sold.

Cash break even of 40,000 units. The selling price is $30.00, the variable cost per unit is $20.00 and depreciation is $10,000. What is the fixed cost?

Fixed cost / (selling price - variable cost) = cash BE ______________ / (30 - 20) = 40,000 ______________/ 10 = 40,000 Fixed Cost = $400,000

When does the cash cycle increase and decrease?

Increases as the inventory and receivables periods get longer; decreases if the company can defer payment of payables and thereby lengthen the payables period.

Sensitivity Analysis

Investigation of what happens to NPV when only one variable is changed; a variation of scenario analysis that is useful for pinpointing the areas where forecasting risk is especially severe.

Short-term financial policies that are flexible with regard to current assets include such actions as:

Keeping large balances of cash and marketable securities; making large investments in inventory; granting liberal credit terms, which results in a high level of accounts receivable.

Short-term financial policies that are restrictive with regard to current assets include such actions as:

Keeping low balances of cash and making little investment in marketing securities; making small investments in inventory; making few or no investment sales, thereby minimizing accounts receivable.

What are two ways a flexible short-term financial policy is reflected?

Maintaining a high ratio of current assets to sales; a low proportion of short-term debt to relative to more long-term financing.

What are two ways a restrictive short-term financial policy is reflected?

Maintaining a low ratio of current assets to sales; a high proportion of short-term debt to relative to less long-term financing.

Compensating Balance

Money kept by the firm with a bank in low-interest or non-interest-bearing accounts as part of a loan agreement.

What is the difference between net working capital and cash?

Net-working capital is cash, plus other current assets, less liabilities. Cash is long-term debt, plus equity, plus current liabilities, less current assets other than cash, less fixed assets.

Will net-working capital always increase when cash increases?

No

What are the four basic categories of cash outflows?

Payments of accounts payable; wages, taxes, and other expenses; capital expenditures; long-term financing expenses.

Explain the connection between a firm's accounting-based profitability and it's cash cycle.

Shortening the cash cycle of a firm will increase its accounting-based profitability and vice versa.

Activities that increase cash

Sources of cash: increasing long-term debt (borrowing over the long term), increasing equity (selling some stock), increasing current liabilities (getting a 90-day loan), decreasing current assets other than cash (selling some inventory for cash), decreasing fixed assets (selling some property).

Marginal Revenue

The change in revenue that occurs when there is a small change in output.

Operational Leverage

The degree to which a firm or project relies on fixed costs.

Scenario Analysis

The determination of what happens to NPV estimates when we ask what-if questions; i.e. "what if unit sales realistically should be projected at 5,500 units instead of 6,000?"

Net Cash Inflow

The difference between cash collections and cash disbursements.

Net Income

The difference between total revenue and total expenses when total revenue is greater.

Marginal Cost

The increase in total cost that arises from an extra unit of production.

Describe the operating cycle and cash cycle. What are the differences?

The operating cycle is the period between the acquisition of inventory and the collection of cash from receivables, whereas the cash cycle is the time between cash disbursement and cash collection. Also, the operating cycle is inventory plus accounts receivable period, and the cash cycle is the difference between the operating cycle and accounts payable period.

Operating Cycle

The period between the acquisition of inventory and the collection of cash from receivables; inventory plus accounts receivable period; describes how a product moves through the current asset account and ends up as cash.

Forecasting Risk

The possibility that errors in projected cash flows will lead to incorrect decisions; also known as estimation risk.

Financial Break-Even

The sales level that results in a zero NPV.

Cash Break-Even

The sales level that results in a zero operating cash flow.

Accounting Break-Even

The sales level that results in zero project net income

Capital Rationing

The situation that exists if a firm has positive NPV projects but cannot find the necessary financing.

Soft Rationing

The situation that occurs when units in a business are allocated a certain amount of financing for capital budgeting.

Cash Cycle

The time between cash disbursement and cash collection; the difference between the operating cycle and accounts payable period.

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.

What keeps the real world from being an ideal one in which net-working capital could always be zero?

This is because there is no "ideal" economy where short-term assets can always be financed with short-term debt, and long-term assets can be financed with long-term debt and equity.

What does it mean to say that a firm has an inventory turnover ratio of 4?

This means the firm bought off and sold their inventory about 4 times during the year.

What are the two short-term borrowing options?

Unsecured borrowing; secured borrowing.

Activities that decrease cash

Uses of cash: decreasing long-term debt (paying off a long-term debt), decreasing equity (repurchasing some stock), decreasing current liabilities (paying off a 90-day loan), increasing current assets other than cash (buying some inventory for cash), increasing fixed assets (buying some property).

Simulation Analysis

A combination of scenario and sensitivity analysis. In order to let both the variables and the values change, we must consider a number of scenarios and almost certainly require compute assistance.