BEC Wiley Module 10

federal agency securities

These securities are obligations of a federal government agency (such as the Federal National Mortgage Association ["Fannie Mae"], Federal Home Loan Bank, Federal Land Bank, and others) that are the responsibility of the agency; these securities are not backed by the good faith and credit of the federal government. As a consequence, these securities are perceived as having slightly more risk than Treasury obligations. In addition, they are not as marketable as Treasury obligations. Therefore, the securities of these agencies have slightly higher yields to compensate for the higher default risk and lower marketability. These securities are offered in various denominations and with a wide range of maturities. The secondary market for these securities is good (while the secondary market for Treasury obligations is excellent).

business risk

This concept refers to the broad macro-risk a firm faces largely as a result of the relationship between the firm and the environment in which it operates. Thus, the nature and extent of this broad risk factor would be a function of both the nature of the firm and the nature of the environment. The firm's business risk would be embodied in the firm's sensitivity (given its nature) to changes in the general economic environment (given its nature).

financial risk

This is the particular risk faced by the firm's common shareholders that results from the use of debt financing, which requires payment regardless of the firm's operating results, and preferred stock, which requires dividends before returns to common shareholders. The payment of interest reduces earnings available to all shareholders and the payment of preferred dividends reduces the retained earnings available to common shareholders. The existence of these obligations increases the risk to common shareholders that variations in earnings will result in inadequate residual profits to reward common shareholders and could result in insolvency

Interest rate risk

This is the risk associated with the effects of changes in the market rate of interest on investments. Generally, the longer the period of an interest-based investment, the greater the perceived risk of the investment.

default risk

This is the risk associated with the possibility that the issuer of a security will not be able to make future interest payments and/or principal repayment. In the United States the lowest uncertainty of future payments—the lowest default risk—is ascribed to U.S. Treasury obligations. They are considered to be free of the risk of default (risk-free) and are used as the benchmark when evaluating the default risk of other securities. For securities that are not considered risk-free, a default risk premium is included in establishing the rate of interest appropriate for a security or for evaluation purposes.

inflationary risk

This risk derives from the possibility that a rise in the general price level (inflation) will result in a reduction in the purchasing power of a fixed sum of money.

liquidation or marketability risk

This risk derives from the possibility that an asset cannot be readily sold for cash equal to its fair value. Two possible elements are implied:Inability to sell for cash in the short termInability to receive fair value in cash for the asset Mitigating this risk would be especially important when making investments that may need to be converted quickly to cash. To compensate for lack of liquidity, a liquidity risk premium is included in establishing the rate of interest appropriate for a security or for evaluation purposes.

political risk

This risk exists to a greater or lesser extent any time a firm has substantive operations in a country other than its home country. Differences in political climate, governmental processes, business culture and ethics, labor relations, market structures, and other factors all add elements of uncertainty and, therefore, risk to the firm.

foreign currency transaction risk

This risk results when a transaction is to be settled in a foreign currency and the exchange rate changes between the date the transaction is initiated and when it is settled.

foreign currency economic risk

This risk results when changes in the exchange rate impacts an entity's future international transactions. As exchange rates change so also does the home currency value of future transactions denominated in the foreign currency. Exchange rate changes may make the future transactions no longer economically viable.

managing the purchases/payment process

This topic recognizes that certain things can be done to conserve cash both before and after obligations are incurred. these include: 1. establish and use charge accounts rather than paying cash. This would include the use of credit cards, which can be limited in amount and types of purchases permitted 2. select suppliers that provide generous deferred payment terms 3. do not pay bills before they are due, expect to take advantage of discounts offered 4. stretch payments, which involves making payments after the established due date. This would be appropriate where it is customary in the industry and where there are no adverse financial affects or where impairment of credit rating would not result.

bankers' acceptances

a draft drawn on a specific bank by a firm that has an account with the bank. If the bank accepts the draft it becomes a negotiable debt instrument of the bak and is available for investment. Primary use is in the financing of foreign transactions. issued in denominations that relate to the value of the transaction for which the acceptance was made. maturities usually from 30 days to 180 days. higher yield than treasury or federal agency obligations.

financial analysis

a firm may undertake its own analysis of a prospective credit customer. can be expensive

remote deposit

a way to process checks received without sending those physical paper checks to the bank. The entity receiving a check uses a special scanner to develop a digital image of the checks and electronically sends the images to its bank where they are processed as a deposit

Moe's Boat Service currently does not offer a discount to encourage its customers to pay early for services provided to them. Moe has discussed with his accountant the possibility of offering a 2% discount to improve its cash conversion cycle. Moe's accountant determined the following: Credit sales expected to remain unchanged at$1,000,000The 2% discount is expected to be taken on 40% of accounts receivable balance amounts.The average accounts receivable would likely decrease by$ 30,000Moe has an opportunity cost of 15% associated with its use of cash. Which one of the following is the dollar amount of net benefit or cost that Moe would obtain if the proposed 2% discount plan is implemented? a. $ 3,500 b. $ 4,500 c. $ 8,000 d. $20,000

a. $3,500 The benefits obtained would be the reduction in working capital required for carrying average accounts receivable of $30,000 multiplied by the opportunity cost of .15 = $4,500. The cost of the plan would be the reduced cash collected on accounts receivable of .02 times the 40% expected to take advantage of the discount (.02 x .40 = .008) times the credit sales, or .008 x $1,000,000 = $8,000. So, the net results would be an increase in cost of $4,500 - $8,000 = - $3,500. Although not clearly stated in the problem "facts," the decrease is intended to be average accounts receivable. As this is an actual AICPA exam question, the wording has been left unchanged.

A temporary increase in merchandise inventory to meet a seasonal demand would best be financed by: a. An increase in current liabilities. b. Issuing bonds. c. Issuing preferred stock. d. Issuing common stock.

a. An increase in current liabilities A temporary increase in merchandise inventory is a short-term increase in assets and would best be financed by an increase in a short-term (current) liability. This is the essence of the hedging principle of finance, also called the principle of self-liquidating debt.

Accounts receivable management is concerned with: I. Policies related to the recognition of accounts receivable.II. Policies related to the collection of accounts receivable. a. Both I and II. b. I only. c. II only. d. Neither I or II.

a. Both I and II

Which of the following inventory management approaches seeks to minimize total inventory costs by considering both the restocking (reordering) cost and the carrying costs? a. Economic order quantity. b. Just-in-time. c. Materials requirements planning. d. ABC.

a. Economic order quantity

foreign currency investment risk

(also Foreign Currency Translation Risk)—This risk results when a firm has a direct foreign investment. As exchange rates change so also does the home currency value of the foreign investment and its operating results.

nondiversifiable risk

(also called systematic or market-related)—The portion or elements of risk that cannot be eliminated through diversification of investments. The factors that constitute nondiversifiable risk usually relate to the general economic and political environment. Since these broad changes affect all firms, diversification of investments does not tend to reduce the risk associated with these factors of the environment.

accounts receivable turnover

(net) credit sales/ average (net) accounts receivable (e.g., beginning + ending/2)

Cash

(the most liquid of assets): Considered to consist of all currency, coins and other demand instruments (checks, money orders, etc.) held either on hand (e.g., day's receipts, change fund, petty cash fund, etc.) or in demand deposit accounts with financial institutions.

benefits of concentration banking

1. cash available for use sooner than it would be otherwise 2. excess cash from multiple locations flow to a single account (or bank) for better control and use 3. arrangements can be made with the concentration bank to automatically invest cash in excess of needed amounts 4. a variation, called "sweeping" takes excess funds from accounts, even within the same bank, at the end of each work day and either invests those funds for very short periods of time in money market funds or other instruments, or uses them to pay down lines of credit

Advantages of preauthorized checks

1. cash is available for use sooner and the amount is highly predictable 2. the firm's handling of collection is reduced considerably, resulting in less cost and greater security than a lockbox arrangement 3. customers may appreciate not having to deal with periodic bills

benefits of the lockbox system

1. cash is available for use sooner than it would be otherwise 2. the firm's time spent handling collections drops considerably, resulting in less cost and greater security 3. reduced likelihood of dishonored checks and earlier identification fo dishonored checks

the basic process of preauthorized checks

1. customer's authorization and idemnification agreement with the firm's bank 2. firm builds database with needed information 3. each period the firm prepares an electronic file and deposit slip and sends them to the bank 4. the bank prints checks, deposits funds to the firm's account, and processes checks through the clearing system in a more automated process, ACH would be used

the basic process of preauthorized debt/credit card charges

1. cutomer provides firm with information and authorization for charges 2. firm charges debit/credit card as provided by authorization 3. firm provides customer with receipt, commonly by e-mail 4. firm's card processor submits charge through debit/credit card interchange system to: firm's bank to recognize amount in firm's account and cusomter's card issuer to charge customer's account 5. charged amount shows up on firm's bank statement as deposit and on customer's debit/credit card statement

assumptions in the economic order quantity model

1. demand is constant during the period 2. unit cost and carrying cost are constant during the period 3. delivery is instantaneous (or a safety stock is maintained)

The advantages of electronic fund transfers

1. drastically reduced float, so firms can defer payments util they are due and still ensure payments are received when due 2. much of the administration can be routine and integrated with a firm's larger accounting and information system, thus reducing cost and errors 3. very low transaction ee costs, especially when compared to traditional check writing and mailing

advantages of remote deposit

1. elimination of the need to physically deliver paper checks to the bank for deposit 2. electronic check images generally clear faster resulting in funds deposited more quickly and bad checks detected sooner 3. process can be integrated with the firm's accounting system 4. digital images of processed checks and deposit are available without the need to prepare duplicate paper copies

benefits of zero balance accounts

1. near elimination of excess cash balances in those accounts 2. very little administration required 3. possible increase in payment float through the use of zero balance accounts in remote banks

benefits of payments by draft

1. provides assurance to the payee that the instrument will be honored for its stated value 2. except for certified checks, drafts do not disclose bank/checking account information to the recipient and, in fact, do not require a checking account 3. automation of bank drafts facilitates the payment of recurring obligations of a fixed amount

benefits of JIT

1. reduce investment in inventory 2. lower cost of inventory transportation, warehousing, insurance, property taxes, and other related costs 3. reduced lead time in replenishing product inputs 4. lower cost of defects 5. less complex and more relevant accounting and performance measures

major benefits of investing in repos

1. the time of the agreement can be adjusted to any length, including s short as one day 2. since the agreement provides for resale of the investment at the original price (plus interest) the risk of market price declines is avoided

mitigating foreign collection problems

1. these methods protect both the seller and the buyer 2. these methods require that payment be made based on presentation of documents conveying title, and that specific procedures have been followed 3. a documentary letter of credit adds a bank's promise to pay the exporter to that of the foreign buyer based on the exporter (domestic entity) complying with the terms and conditions of the letter of credit 4. A documentary draft is handled like a check from a foreign buyer, except that title does not transfer to that buyer until the draft is paid.

standby financing

A line of credit provides an effective means of arranging "standby" financing. The credit is prearranged and can be used when needed, thus reducing the cost associated with any idle borrowing.

supply chain management

A supply chain is the entire sequence of processes involved in the sourcing, production, and distribution of a good. The primary objective of supply chain management is to meet end-user demand with the most efficient resource usage. Supply chain management often is used in the efficient management of inventory.

money order

An order to pay a sum of money, often sold by non-bank institutions (e.g., United States Postal Service, Western Union, etc.). Functions the same as a cashier's check, but usually has a limited dollar amount (e.g., $1,000 is a common limit).

certified check

An order to pay in the form of a customer's check that has been "certified" as having the funds by the bank. When a bank certifies a check, it immediately withholds the amount of the check from the writer's account and the check becomes the bank's obligation to pay.

The following information was taken from the income statement of Hadley Co.: Beginning inventory17,000Purchases56,000Ending inventory13,000 What is Hadley Co.'s inventory turnover? a. 3. b. 4. c. 5. d. 6.

B. 4. Inventory turnover is computed as: Cost of Goods Sold/Average Inventory. Cost of goods sold (COGS) is the sum of beginning inventory (BI) plus purchases (P), which equals cost of goods available for sale (COGAS), less ending inventory (EI); that difference is cost of goods sold. It would be computed as: BI $17,000 + P $56,000 = COGAS $73,000 - (EI) $13,000 = (COGS) $60,000. Average inventory (AI) is computed as (BI) $17,000 + (EI) $13,000/2, or (AI) $30,000/2 = $15,000. Thus, inventory turnover is (COGS) $60,000/(AI) $15,000 = 4.

JIT quality management

Because inventory is squeezed out of every stage of the production process, inputs to the process must be high quality, otherwise a defective input likely would stop production. Therefore, there must be total control of quality of inputs. This is accomplished by working closely with suppliers to insure quality in their production process, as well as implementing quality practices within its own processes.

inventory buffers

Because production is in anticipation of sales, inventories are maintained at every level in the process as buffers against unexpected increased demand. If demand is less than production, finished goods inventory accumulates.

JIT supplier purchases characteristics

Close working relationships are developed with a limited number of suppliers to help coordinate operating interrelationships and to help assure timely delivery of quality inputs. The physical distance between supply source and production facilities is minimized. Goods are purchased only in the quantity needed to meet production demand and entered directly in the production process.

early payment

Discounts offered for early payment of trade accounts payable are usually significant, many with an effective annual interest rate of over 30%, and should be taken if possible.

short-term borrowing

Generally, short-term borrowing does not require collateral and does not impose restrictive covenants.

supply push

Goods are produced in anticipation of a demand for the goods. Therefore, the characteristics of the products available to the end user have already been decided—colors, features, sizes, etc.

JIT demand pull

Goods are produced only when there is an end-user demand. Goods are produced with the characteristics desired by the customer and in the quantity demanded.

effective cost of borrowing

If current liabilities (e.g., short-term notes, line of credit, etc.) require maintaining a compensating balance (greater than any balance that would otherwise be maintained with the institution), the effective cost of borrowing is greater than the stated cost.

price stability

Investments should not be subject to market price declines that would result in significant losses if the securities were sold for cash. Investments in most debt instruments have an associated interest rate risk, the risk that derives from the relationship between the rate of interest paid by a security and the changing rate of interest in the market. Specifically, the market value of an existing debt instrument varies inversely with changes in the market rate of interest. Thus, the interest rate risk is that the market rate of interest will increase, resulting in a decrease in the market value of an investment. If sold, that investment would incur a loss and, as a result, less cash would be available. Investing in securities that mature in a short period mitigates this risk.

JIT accounting issues

JIT uses simplified cost accounting. It eliminates or combines inventory accounts because inventory is reduced or eliminated. Many more accounts are considered direct cost (e.g., material handling, equipment depreciation, and repairs and maintenance), thus reducing amounts allocated on a somewhat arbitrary basis. The accounting focuses less on variance analysis and more on aggregate measures, including days inventory on hand, return on assets, lead-time, and others.

production characteristics

MRP is based on long set-up times and long production runs; it is not flexible. It uses specialized labor and function-specific equipment.

operational activity ratios

Measure the efficiency with which a firm carries out its operating activities.

capital turnover

Measures how well the number of times that the average owners' equity is represented by sales (revenue) during a period. It shows how well the entity is using owners' equity to generate revenue. (This is different from return on owners'/shareholders' equity, which uses net income [not revenue] as the numerator.) It is computed as: Capital turnover = Annual sales (or revenue)/Average owners' equity.

times interest earned ratio

Measures the ability of current earnings to cover interest payments for a period. It is measured as: Times Interest Earned Ratio = (Net Income + Interest Expense + Income Tax Expense) / Interest Expense OR Times Interest Earned Ratio = Income before Interest Expense and Income Tax Expense (i.e., EBIT) / Interest Expense

times preferred dividends earned ratio

Measures the ability of current earnings to cover preferred dividends for a period. It is computed as: Times Preferred Dividends Earned Ratio = Net Income / Annual Preferred Dividend Obligation

operating cycle length

Measures the average length of time between the acquisition of inventory and the collection of cash from the sale of that inventory, including the time to collect accounts receivable if sales are made on account.

average receivables

Measures the average number of days required to collect receivables; it is a measure of the average age of receivables. It is computed as: Number of days' sales in average receivables = 300 or 360 or 365 (or other measure of business days in a year) / Accounts receivable turnover (computed in A, above)

average payables

Measures the average number of days required to pay accounts payable; it is a measure of the average age of payables. It is computed as:Number of days' purchases in average payables = 300 or 360 or 365 (or other measure of business days in a year) / Accounts payable turnover (computed in E, above)

working capital

Measures the extent to which current assets exceed current liabilities and, thus, are uncommitted in the short term. It is expressed as: Working Capital = Current Assets - Current Liability

number of days' supply in inventory

Measures the number of days inventory is held before it is sold or used. Indicates the efficiency of general inventory management. It is computed as: Number of days' supply in inventory=300 or 360 or 365 (or other measure of business days in a year) / Inventory turnover (computed in C, above) OR Number of days' supply in inventory=Ending inventory/[Cost of goods sold/365](or other measure of business days in a year)

average collection period

Measures the number of days on average it takes an entity to collect its accounts receivable; the average number of days required to convert accounts receivable to cash. It is computed as: Average Collection Period = (Days in Year × Average Accounts Receivable) / Credit Sale for Period

ending receivables

Measures the number of days sales in end of period receivables. It is computed as: Ending (Net) receivables / [Net credit sales / 365] (or other measure of business days in a year)

ending payables

Measures the number of days' purchases in ending accounts payable. It is computed as:Ending accounts payable/[Cost of goods sold/365] (or other measure of business days in a year)

accounts payable turnover

Measures the number of times that accounts payable turn over (are incurred and paid) during a period. Indicates the rate at which an entity pays its average accounts payable and, thereby, how well it manages paying its obligations. Accounts payable turnover=Credit purchases/Average accounts payable(e.g.,(Beginning+Ending)/2) If the amount of credit purchases is not available, an entity may use cost of goods sold, adjusted by changes in inventory. Thus, that computation of accounts payable turnover would be:(Cost of goods sold + Ending inventory - Beginning inventory)/Average accounts payable

accounts receivable turnover

Measures the number of times that accounts receivable turnover (are incurred and collected) during a period. Indicates the quality of credit policies (and the resulting receivables) and the efficiency of collection procedures (net) credit sales/ average (net) accounts receivable

inventory turnover

Measures the number of times that inventory turns over (is acquired and sold or used) during a period. Indicates over or under stocking of inventory or obsolete inventory. It is computed as: cost of goods sold/ average inventory

operating cash flow ratio

Measures the quantitative relationship between cash from operations and current liabilities. It shows the number of times current liabilities are covered with cash generated from operations during the period. It is computed as: Cash Flow from Operating Activities / Ending Current Liabilities

defensive interval raito

Measures the quantitative relationship between highly liquid assets and the average daily use of cash in terms of the number of days that cash and assets that can be quickly converted to cash can support operating costs. It is computed as: Defensive-Interval Ratio = (Cash + Cash Equivalents + (Net) Receivables + Short-term Marketable Securities) / Average Daily Cash Expenditures

JIT production characteristics

Production occurs in work centers or cells in which the full set of operations to produce a product are carried out. Workers are trained to operate multiple pieces of equipment and robots are used where feasible. Each work center functions like a mini-factory.

Quality Management

Quality standards are set at an acceptable level, allowing for a certain level of defects.

supplier/purchases characteristics

Relationships with suppliers are impersonal with purchases made through bids accepted from many suppliers. The low bid is usually accepted, regardless of the supplier's location. Purchases are normally made in large lots, which may be greater than what is immediately needed.

CV

SD/AR SD = standard deviation of investment average return AR= average rat of return of investment the lower an investment's coeffecient of variation the better its total risk-return trade off. If the AR is zero or negative the resulting ratio will not be valid and the CV cannot be used to assess risk for that investment

short-term liabilities

Short-term liabilities are most appropriately incurred in connection with assets which will generate cash in the short term to repay the liability. This is the essence of the principle of self-liquidating debt, also called the hedging principle of financing.

accounts receivable cycle

The (average) period of time from selling inventory on account (recognizing account receivable) until the account is collected (collection of account receivable). It is measured using the number of days' sales in accounts receivable.

inventory conversion cycle

The (average) period of time from the acquisition of inventory until it is resold (or used). It is measured using the number of days' supply in inventory.

accounts payable cycle

The (average) period of time from the purchase of inventory on account (recognizing account payable) until the account is paid (payment of account payable). It is measured using the number of days' purchases in accounts payable.

cash budgets

The basis for determining a firm's cash needs is its cash budget, which shows expected cash receipts and disburesements for each budget period. If the projected cash balance is higher than the needed amount, management can plan to make investments or pay down existing debt. On the other hadn't, if a cash shortage is projected, management can either reduce cash requirement, make plans to borrow, or otherwise plan for the shortfall

JIT inventory reduction

The customers' demand pulls inventory through the production process in that each stage produces only what is needed by the next stage and outside purchases are made only as needed. Thus, excess raw materials, work-in-process and, ideally, finished goods inventories are greatly reduced or eliminated.

ratio analysis

The development of quantitative relationships between various elements of a firm's financial and other information.

accelerating and controlling cash inflows

The time between when a firm establishes a claim to cash and when that cash is available to the firm to reinvest should be as short as possible.

economic order quantity

There is a trade-off between inventory ordering cost and inventory carrying cost. Specifically, the larger the quantity ordered, the lower the per unit cost of ordering (clerical, transportation, handling, etc.), but the higher the carrying cost (warehousing, insurance, property taxes, financing costs, etc.). Determining the order size that will minimize total inventory cost is solved using the economic order quantity model. The basis for the model recognizes that: total inventory cost = total order cost + total carrying cost total inventory cost = [(T/Q X O] + [(Q/2) X C] EOQ = sq rt (2 TO/C)

interest rate swaps

These contracts are agreements between two parties (counterparties) to exchange sets of interest-rate-based future cash flows. Under the terms of the contract, one party agrees to pay a fixed rate of interest and receive a floating rate of interest and the other party agrees to pay a floating rate of interest and receive a fixed rate of interest. The floating rate is based on a benchmark rate such as the prime rate or LIBOR.

forward and future contracts

These contracts are agreements to buy or sell a specific asset at a specified price at a future date. Technically, forward and futures contracts differ in how they are executed. Forward contracts are carried out directly between two parties (i.e., "over the counter"), not on an organized exchange, and can be customized between the two parties. Futures contracts are carried out on an organized exchange (futures exchange), and have standardized quantities, time periods, etc. Because they are carried out through an organized exchange, futures contracts provide greater protection against default and liquidity risks than forward contracts carried out directly between two parties.

option contracts

These contracts are similar to forward and futures contracts, but provide the buyer the choice (option) of whether or not to buy or sell a specific asset at a specified price on or before a future date, whereas a forward or futures contract requires the parties to execute the buy/sell terms of the contract. A call option (contract) grants the owner the right (but not the obligation) to buy some underlying asset. A put option (contract) grants the owner the right (but not the obligation) to sell some underlying asset.

North Bank is analyzing Belle Corp.'s financial statements for a possible extension of credit. Belle's quick ratio is significantly better than the industry average. Which one of the following factors should North consider as a possible limitation of using this ratio when evaluating Belle's creditworthiness? a. Fluctuating market prices of short-term investments may adversely affect the ratio. b. Increasing market prices for Belle's inventory may adversely affect the ratio. c. Belle may need to sell its available-for-sale investments to meet its current obligations. d. Belle may need to liquidate its inventory to meet its long-term obligations.

a. Fluctuating market prices of short-term investments may adversely affect the ratio. The quick ratio (also called the acid-test ratio) is the relationship between current assets that can be converted quickly to cash and total current liabilities. Expressed as a formula, it is: Quick Ratio = Quick Assets/Current Liabilities. Quick assets normally include cash, accounts receivable, and short-term investments (also called marketable securities). Note that quick assets do not include all current assets; it excludes inventories and most prepaid items. Because short-term investments are reported on the balance sheet at fair market value at the balance sheet date, fluctuations in the market price over time would change the quick ratio. For example, if the balance sheet is dated December 31, the quick ratio would reflect the quick assets and current liabilities at that point in time. If the market value of short-term investments decreases after December 31, the quick ratio as of December 31 would overstate the ratio after the market value declines.

Can a firm over invest and/or under invest in net working capital? a. Over invest Yes; under invest Yes b. Over invest Yes; under invest No c. Over invest No: under invest Yes d. Over invest No; undr invest No

a. Over invest Yes; under invest Yes

If a CPA's client expected a high inflation rate in the future, the CPA would suggest to the client which of the following types of investments? a. Precious metals. b. Treasury bonds. c. Corporate bonds. d. Common stock.

a. Precious metals. Of the alternative answer choices listed, during a period of high inflation, the best investment is precious metals. Because of their scarcity, precious metals tend to increase in market value during periods of inflation. Treasury bonds and corporate bonds, both of which typically pay fixed rates of return, face market interest rate risk and will lose market value as inflation drives up the general rate of interest. While common stock may provide some protection during a period of high inflation, that inflation causes the costs of productive inputs to increase, therefore, increasing pressure on company profits and returns to common stock shareholders.

Ratio analysis and related measures can be used to compare: a. a firm over time and across firms b. a firm over time only c. across firms only d. neither a firm over time nor across firms

a. a firm over and across firms

Which of the following, if denominated in a foreign currency, is/are subject to currency exchange risk? a. accounts receivable and accounts payable b. accounts receivable only c. accounts payable only d. neither accounts receivable nor accounts payable

a. accounts receivable and accounts payable

Which of the following considerations typically would be important in selecting investments for the temporary use of "excess" cash? a. safety of principal and ready marketability b. safety of principal c. ready marketability d. neither safety of principal nor ready marketability

a. after of principal and ready marketability

A financial institution looking to assess its investment portfolio's exposure to price changes most likely would use which of the following techniques? a. Market value at risk analysis. b. Cash flow at risk analysis. c. Earnings at risk analysis. d. Back testing analysis

a. market value at risk analysis A financial institution would most likely assess its investment portfolio's exposure to price changes using market value at risk analysis. The risk of changes in the price of an investment portfolio is, as the concept implies, the potential for decline in the market price, or market value, of the investment portfolio.

Cash management is concerned with assuring that a firm does not have a. too little cash and too much cash b. too little cash c. too much cash d. neither too little nor too much cash

a. too little cash and too much cash The general objective of cash management is to maintain a cash balance between holding too little cash and holding too much cash. A firm must maintain adequate cash on an on-going basis to meet its cash-requiring obligations that arise in the normal course of its business activities--accounts payable, salaries and wages, etc. On the other hand, holding too much cash (excess cash over that needed for immediate obligations) is an inefficient use of resources, since the return on unneeded cash usually is less than could be earned if the cash were invested in assets with a higher return (e.g., securities, inventory, capital projects, etc.).

Are the following fixed-rate investments subject to interest rate risk during their life? domestic bonds, international bonds, us treasury bills

all yes

diversifiable risk

also called unsystematic, firm-specific, or company-unique)—The portion or elements of risk that can be eliminated through diversification of investments. In our discussion of capital budgeting we noted that a firm could mitigate certain risks associated with individual projects by investing in diverse kinds of projects. Similarly, a firm would reduce certain risks associated with its securities investments by diversification of the securities in its portfolio.

liquidity

also known as solvency measures the ability of the firm to pay its obligations as they become due these measures are particularly appropriate for use in managing working capital

acid test ratio

also known as the quick ratio Measures the quantitative relationship between highly liquid assets and current liabilities in terms of the "number of times" that cash and assets that can be converted quickly to cash cover current liabilities. It is computed as: Acid Test Ratio = (Cash + Cash Equivalents + (Net) Receivables + Short-term Marketable Securities) / Current Liabilities

Electronic Funds Transfers

an electroic means of transferring funds similar to wire transfer but used in a broader context. Rather than payments occurring through the use of checks or drafts, payments are initiated and processed based on the transfer of computer files between entities

wire transfer

an electronic means of transferring funds between banks. The Federal Reserve Bank Wire System and a private wire service operate in the United States. Because it is a relatively expensive method of transferring funds, wire transfers should be used only for large transfers, for example, as a means of moving large sums in a concentration banking arrangement

Bank draft

an order to pay drawn by a bank on itself or on a correspondent bank with which the issuing bank has an account. These kinds of drafts are used by banks dealing with other banks and are "sold" by banks to customers. When purchased, the customer pays the bank the amount of the draft (plus a fee) and the bank issues the customer a draft (check) drawn on itself or its account with another bank. Thus, the customer has a check that is guaranteed to be paid when presented. Bank drafts can be issued on an: Individual basis—A single draft for a specified amount Automatic basis—Recurring drafts for a fixed amount issued periodically and charged to a customer's account

cashier's check

an order to pay drawn by a bank's cashier on an account of the bank. Drawn only on the bank that issues the check and are done only on an individual basis

On March 1, 2019, Estes Company purchased goods totaling $1,000 from one of its suppliers with terms of 2/15, n/45. If Estes pays the invoice on April 10, 2019, which one of the following is the amount Estes would pay? a. $1,020 b. $1,000 c. $980 d. $850

b. $1,000 The amount Estes would pay on April is $1,000. This is the full amount of the invoice which is appropriate because Estes did not pay within 15 days of the invoice, resulting in the loss of an early payment discount.

A company has credit sales of $20,000 in January, $30,000 in February, and $50,000 in March. The company collects 75% in the month of sale and 25% in the following month. The balance in accounts receivable on January 1 was $25,000. What amount is the balance in accounts receivable at closing on March 31? a. $7,500 b. $12,500 c. $37,500 d. $45,000

b. $12,500 The March 31 balance in accounts receivable consists only of 25% of March credit sales. Since all sales are collected by the end of the month following the sales, only 25% of March sales would remain outstanding as of March 31. The amount is calculated as .25 × $50,000 = $12,500.

A company has cash of $100 million, accounts receivable of $600 million, current assets of $1.2 billion, accounts payable of $400 million, and current liabilities of $900 million. What is its acid-test (quick) ratio? a. 0.11 b. 0.78 c. 1.75 d. 2.11

b. 0.78 The acid-test ratio (also known as the quick ratio) is computed as the relationship between highly liquid assets and current liabilities. Highly liquid assets include cash, accounts receivable, and marketable securities. In this case, the company has only cash and accounts receivable. Therefore, the correct calculation is $100m (cash) + $600m (accounts receivable) = $700m/$900 (current liabilities) = 0.777 (or 0.78).

Creditco, Inc. sells goods on credit terms of "net 30 days." If Creditco has efficient credit policies and collection practices, which one of the following would most likely be its accounts receivable turnover? a. 10 times per year. b. 12 times per year. c. 24 times per year. d. 36 times per year.

b. 12 times per year. The formal calculation of accounts receivable turnover (ART), which measures how many times during a year average accounts receivable are collected, is: ART = Credit Sales/Average Accounts Receivable. Since, in this question, we are told that Creditco has efficient credit and collection, we logically can assume that its collections of accounts receivable is consistent with its credit terms. Creditco's credit terms of "net 30 days" mean that it does not offer customers a discount for paying early, but that its customers have 30 days to pay the amount due to Creditco. If Creditco collects amounts due in a timely manner, its accounts receivable should be outstanding for 30 days on average (or would turn over every 30 days). If accounts receivable turn over every 30 days, then 360days/30days = 12 times per year.Like most ratios, the usefulness of the accounts receivable turnover is enhanced by comparing it with industry averages or with Creditco's turnover rate over time.

Super Sets, Inc. manufactures and sells television sets. All sales are finalized on credit with terms of 2/10, n/30. Seventy percent of Super Set customers take discounts and pay on day 10, while the remaining 30% pay on day 30. What is the average collection period in days? a. 10. b. 16. c. 24. d. 40.

b. 16 The average collection period is 16 days, computed as: Customers paying on day 10 = .70 x 10 days= 7 days average.Customers paying on day 30 = .30 x 30 days= 9 days average.Average collection period= 16 days On average, 70% are outstanding for 10 days and 30% are outstanding for 30 days. By getting the weighted average of each group and summing them, the average collection period is determined.

Financial information about a company is as follows: Receivables$ 4,000,000Inventory2,600,000 Payables3,700,000 Sales50,000,000 Cost of goods sold45,000,000 Assuming a 365-day year, what is the number of days in the company's cash conversion cycle? a. 18.2 days. b. 20.3 days. c. 21.2 days. d. 23.5 days.

b. 20.3 days. The cash conversion cycle measures the time between when cash is paid to suppliers and when cash is collected from customers. It is computed using the inventory conversion cycle (DIO) plus the accounts receivable conversion cycle (DPO) less the accounts payable conversion cycle (DPO). For this question, the computation is: lDaysinventoryoutstanding(DIO)=Averageinventory/Costofgoodssoldperday=$2,600,000/($45,000,000/365)=$2,600,000/$123,288=21.08daysDayssalesoutstanding(DSO)=Averageaccountsreceivable/Salesperday=$4,000,000/($50,000,000/365)=$4,000,000/$136,986=29.20daysDayspayableoutstanding(DPO)=Averagepayables/COGSperday=$3,700,000/($45,000,000/365)=$3,700,000/$123,288=30.01daysDIO+DSO−DPO=21.08days+29.20days−30.01days=20.27days=20.3days(rounded).

The main reason that a firm would strive to reduce the number of days' sales outstanding is to increase a. Accounts receivable. b. Cash. c. Contribution margin. d. Cost of goods sold.

b. Cash The number of days' sales outstanding measures the average number of days required to collect receivables. A reduction in the number of days' sales outstanding would serve increase cash by collecting cash sooner and reducing the amount of accounts receivable outstanding.

Which one of the following would likely be the most appropriate form of investment for a firm's temporary excess cash? a. Common stock b. Commercial paper c. Corporate bonds d. Municipal bonds

b. Commercial paper Because temporary excess cash is available for only a limited time, it should be invested in short-term securities that offer safety of principal, price stability and liquidity. Commercial paper consists of short-term unsecured promissory notes issued by large, established firms with high credit ratings. As a consequence, they offer safety of principal and price stability. While the market for commercial paper is somewhat limited, they nevertheless satisfy the requirements of short-term investments better than either stocks or bonds.

In managing its working capital, your firm tries to follow the hedging principle of finance. Which one of the following would be too aggressive to be consistent with that principle as applied to working capital? a. Financing short-term needs with long-term funds. b. Financing long-term needs with short-term funds. c. Financing seasonal needs with short-term funds. d. Financing a permanent build-up in inventory with long-term debt.

b. Financing long-term needs with short-term funds. Under the hedging principle of finance, assets are acquired with financing that matches the life of the asset. Thus, short-term assets would be financed with short-term liabilities and long-term assets would be financed with long-term liabilities or equity. The financing of long-term needs with short-term funds would be an aggressive approach to financing long-term needs that would not be consistent with the hedging principle.

In computing the reorder point for an item of inventory, which of the following factors are used? I. Cost of inventory. II. Inventory usage per day. III. Acquisition lead-time. a. I and II are correct. b. II and III are correct. c. I and III are correct. d. I, II and III are correct.

b. II and III are correct Determining the level of stock (inventory) at which the inventory should be reordered is a function of the minimum level of inventory to be maintained, referred to as the safety stock, and the length of time it takes to receive inventory after it is ordered, referred to as the lead-time or delivery-time stock. Both the safety stock and the lead-time stock are based on the rate of inventory usage. The calculation of the reorder point would be: Reorder point = safety stock + delivery-time stock The cost of inventory does not enter into the determination of the reorder point (but it does enter into the optimum quantity to reorder).

Information that relates to a firm's solvency is used primarily to assess a firm's ability to a. Convert assets to cash. b. Pay its debts. c. Generate profits. d. Collect its receivables in a timely manner.

b. Pay its debts. Measures related to the solvency of a firm are primarily concerned with the ability of a firm to pay its debts as they become due.

Bobcat Company has a current ratio of 2:1. Which one of the following transactions could Bobcat use to increase its current ratio? a. Borrowing cash by giving a short-term note. b. Paying off accounts payable. c. Paying off long-term debt. d. Factoring accounts receivable.

b. Paying off accounts payable. A 2:1 current ratio means that Bobcat has twice the book value of current assets as its book value of current liabilities. For example, current assets (CA) of $200,000, with current liabilities (CL) of $100,000, would give a current ratio of CA/CL = $200,000/$100,000 = 2:1. Because Bobcat's current ratio is greater than 1:1, an equal dollar decrease in current assets and current liabilities will be a greater percentage decrease in current liabilities than in current assets, resulting in an increase in the ratio of remaining current assets and liabilities. Assuming the above values, paying off $10,000 of accounts payable would result in a reduction in the current asset cash ($200,000 - $10,000 = $190,000), and an equal dollar reduction in the current liability accounts payable ($100,000 - $10,000 = $90,000). The resulting new current ratio would be $190,000/$90,000 = 2.11:1, an increase over the previous 2.00:1.

Three suppliers offer Ruby Co. different credit terms as follows: Bandy Co. offers terms of 1.5/15, net 30. Carryl Co. offers terms of 1/10, net 30. Platt Co. offers terms of 2/10, net 60. Ruby Co. would have to borrow from a bank at an annual rate of 10% to take any cash discounts. Based on a 360-day year, which of the following options would be most attractive for Ruby Co.? a. Purchase from Platt Co., pay in 60 days, and do not borrow from the bank. b. Purchase from Bandy Co., pay in 15 days, and borrow from the bank. c. Purchase from Carryl Co., pay in 10 days, and borrow from the bank. d. Purchase from Bandy Co., pay in 30 days, and do not borrow from the bank.

b. Purchase from Bandy Co., pay in 15 days, and borrow from the bank. his option would be the most attractive for Ruby. By borrowing from the bank, paying in 15 days and taking the 1.5% discount would be the most beneficial option.The cost of this option would be computed as: Discount percentage/(100% − Discount %) × 360 days/(Total pay period − Discount period) For this option the values would be: [.015/(1.00 - .015)]× [360/(30 - 15)] = .01522× 24 = .3653 (or 36.53%), the annual cost of not taking the discount offered. By borrowing from the bank at 10% and taking advantage of the discount, Ruby would benefit by .3653 annual rate saved less .10 annual cost of borrowing = .2653.

Which one of the following named risks cannot be mitigated through diversification of investments? a. Unsystematic risk. b. Systematic risk. c. Firm-specific risk. d. Company unique risk.

b. Systematic risk. Systematic risk, also called non-diversifiable risk or market-related risk, cannot be mitigated or eliminated through diversification of investments. This type of risk is most closely associated with elements of the macroeconomic environment in which a firm operates and would include, for example, interest rate risk and inflation risk.

Collection float for a firm is best described as the a. Time between when a firm receives a check and when the funds are available for use by the firm. b. Time between when a customer mails a check and when the funds are available for use by the firm. c. Time between when a customer mails a check and when the check is received by the firm. d. Time between when a firm deposits a check and when the funds are available for use by the firm.

b. Time between when a customer mails a check and when the funds are available for use by the firm. Collection float is best described as the time between when a customer mails a check in payment of an obligation and when the funds from that check are available for use by the firm. It includes the time the check is in the mail, the time it takes the firm to process the check when it is received, and the time it takes for the processed check to clear the bank and the related funds deposited in the receiving firm's account.

Which one of the following cash management techniques focuses on cash disbursements? a. Lock-box system. b. Zero-balance account. c. Pre-authorized checks. d. Depository transfer checks.

b. Zero-balance account. A zero-balance account is a cash management technique that permits control over cash outflows by using a checking account that has a zero ($0) real balance because payments made from the account exactly equal deposits to the account. From a financial management perspective, a zero-balance account arrangement enables decentralized units to write checks drawn on one of that unit's accounts that has no real balance. As those checks clear the bank they create a temporary negative balance in the account. At the end of each day, the bank transfers an amount from another of the firm's accounts to exactly cover the negative balance in the account. Thus, it is a zero-balance account. Zero-balance accounts also are used in another way to control cash disbursements, often as an element of internal control. In this context, a firm deposits to an account only an amount equal to known payments to be made from that account. For example, a firm might use a zero-balance account for its payroll. Once the dollar amount of the payroll checks is determined, only that amount is deposited to the account against which the checks are drawn. As a consequence, no more than the total amount of payroll checks can be paid out of the account. In addition, it is easier to reconcile the account and the real balance will be zero.

Which of the following factors is inherent in a firm's operations if it utilizes only equity financing? a. Financial risk. b. Business risk. c. Interest rate risk. d. Marginal risk.

b. business risk A firm that utilizes only equity financing would face business risk. Business risk derives from the broad, macro-risk a firm faces largely as a result of the relationship between the firm and the environment in which it operates. The extent of that risk would depend on the susceptible of the firm to changes in the overall economic climate.

risk-reward trade off of inventory

between over investing in inventory so as to avoid shortages and incurring excessive cost and underinvesting in inventory to save cost but incurring the risk of shortages

At the end of its fiscal year, Krist, Inc. had the following account balances: Cash$ 5,000 Accounts receivable10,000 Inventory20,000 Accounts payable15,000 Short-term note payable5,000 Long-term note payable35,000 What is Krist's quick (acid-test) ratio? a. 0.273 b. 0.636 c. 0.750 d. 1.750

c. 0.750 The quick (or acid-test) ratio is .750. The quick ratio measures the quantitative relationship between highly liquid assets and current liabilities in terms of the "number of times" that cash and assets that can be converted quickly to cash cover current liabilities. It is computed as: Acid-test Ratio = (Cash + (Net) Receivables + Marketable Securities) / Current Liabilities For the facts given, the calculation is: $5,000 + $10,000/$15,000 + $5,000, or $15,000/$20,000 = .750 quick (acid-test) ratio Inventory is not considered an asset that can be quickly converted to cash; long-term note payable is not a current liability.

Cyco, Inc. determined the following concerning its operating activities: Accounts receivable conversion cycle18 days Accounts payable conversion cycle21 days Inventory conversion cycle24 days Which one of the following is the length of Cyco's cash cycle? a. 42 days. b. 39 days. c. 21 days. d. 15 days.

c. 21 days The cash cycle can be determined as the operating cycle (i.e., inventory conversion cycle [24 days] + accounts receivable conversion cycle [18 days]) less the accounts payable conversion cycle [21 days]. Thus, Cyco's cash cycle would be computed as 24 + 18 = 42 - 21 = 21 days, the correct answer.

Harper, Inc. is considering a short-term loan of $100,000 to fund a temporary increase in seasonal inventory. Its bank has offered a 180-day loan at an annual rate of 7.00%, with the requirement that Harper maintain a $10,000 compensating balance in its account during the period of the loan. Harper would not normally maintain such a balance in its account. If Harper accepts the loan terms from its bank, using a 360-day year, which one of the following most closely approximates the annual percentage (interest) rate (APR) on the loan? a. 3.89% b. 7.00% c. 7.78% d. 15.56%

c. 7.78% The annual percentage (interest) rate (APR) is 7.78%. The annual percentage rate (APR) is the annualized effective interest rate, without compounding, on borrowings that are for a fraction of a year. The APR is computed as the effective interest rate for the fraction of a year multiplied by the number of times the fraction occurs within a year. With the facts given, the effective interest rate for 180 days is the cost of the borrowing, $3,500 ($100,000 × .07 × 180/360 = $3,500), divided by the proceeds available from the loan, $90,000 ($100,000 - $10,000 compensating balance = $90,000), or $3,500/$90,000 = 3.89%. Since there are 2 periods of 180 days in a 360-day year, the APR is 3.89% × 2 = 7.78%.

For 2014 Turnco Inc. has annual total sales of $500,000, 50% of which are made on credit. If its receivables turnover for 2014 is 5, what is Turnco's average days collection period (rounded to the nearest day) using a 360-day year? a. 14 days. b. 36 days. c. 72 days. d. 139 days.

c. 72 days Turnco's average collection period is 72 days. This answer is calculated as the number of days in a year divided by the receivables turnover, or 360/5 = 72 days. The information about the level of sales and the percentage that was credit sales is unnecessary information and is intended to distract.

Following the hedging principle of financing, short-term liabilities would appropriately be used to finance which one of the following? a. The acquisition of plant machinery. b. The payment of bond principal at maturity. c. An opportunity to acquire inventory at a bargain price. d. The acquisition of a patent.

c. An opportunity to acquire inventory at a bargain price. Under the hedging principle of financing, short-term liabilities (e.g., accounts payable or short-term note payable) should be used to finance short-term assets, which would include inventory.

Which one of the following is not a characteristic of a just-in-time inventory system? a. Reducing distance and time between related production operations. b. Establishing close, long-term relationships with suppliers. c. Decreasing the number of deliveries from suppliers. d. Reducing raw material safety stock.

c. Decreasing the number of deliveries from suppliers. Under a just-in-time inventory system, a firm reduces its inventory on-hand and relies on suppliers to make more frequent deliveries -- deliveries that provide inventory just in time to be input into the production process. Thus, decreasing the number of deliveries from suppliers is not a characteristic of a just-in-time inventory system; rather, such a system increases the number of deliveries.

Titles of ratios frequently include the terms "on" and "to." When used in ratio titles, these terms imply the use of which one of the following mathematical functions? a. Subtraction. b. Multiplication. c. Division. d. Squaring.

c. Division

Which of the following characteristics is a primary benefit of a just-in-time inventory system for raw materials? a. Decreases deliveries required to maintain production. b. Increases standard delivery quantity. c. Eliminates non-value-added operations. d. Increases total number of suppliers to ensure competitive bidding.

c. Eliminates non-value-added operations. Using a just-in-time inventory system would be intended to eliminate non-value-added operations. To accomplish that objective a just-in-time system would seek to: 1. Reduce investment in inventory. 2. Lower cost of inventory transportation, warehousing, insurance, property taxes, and other related costs. 3. Reduce lead time in replenishing product inputs. 4. Lower cost of defects. 5. Use less complex and more relevant accounting and performance measures.

Which one of the following is not used in determining the operating cycle of an entity? a. Accounts payable conversion cycle. b. Inventory conversion cycle. c. Fixed asset conversion cycle. d. Cash conversion cycle.

c. Fixed asset conversion cycle. The fixed asset conversion cycle is not a component used in determining the operating cycle of an entity. The concept of the fixed asset cycle is not commonly used, but when used refers to the period that covers the acquisition, use and disposal of fixed assets. Fixed asset life is not an element included in measuring the operating cycle.

Which of the following quantitative factors, when compared to its industry average, could be an indicator of potential corporate failure? a. High cash flow to total liabilities b. High retained earnings to total assets c. High fixed cost to total cost structure d. High fixed assets to noncurrent liabilities

c. High fixed cost to total cost structure As the name implies, fixed cost to total cost measures the ratio of fixed cost to total cost and is one measure of operating leverage. A high ratio of fixed cost to total cost indicates instability in earnings that results because fixed costs are incurred regardless of the level of revenues. Thus, when fixed costs constitute a high proportion of a firm's total costs, a significant reduction in revenues may result in losses, since the fixed cost will be incurred even in the face of a significant reduction in revenues. Such losses could put the firm at risk for failure.

When a financial manager takes action to minimize the firm's investment in current assets, which one of the following risks is likely to increase? a. Accounts receivable defaults may increase. b. Inventory spoilage may increase. c. Inventory shortages may increase. d. Inventory obsolescence may increase.

c. Inventory shortages may increase Reducing investment in current assets is likely to increase the risk that inventory shortages will increase. Excessive reductions in inventory may result in inventory shortages, which cause interruptions in operations and an inability to meet production requirements

Which of the following types of risk can be reduced by diversification? a. High interest rates. b. Inflation. c. Labor strikes. d. Recession.

c. Labor strikes. Risks that can be reduced by diversification (also called diversifiable risk or unsystematic risk) are risks that relate to a particular undertaking, firm or industry, and typically are not associated with macroeconomic conditions. Diversifiable risk are mitigated by engaging in multiple different investments or undertakings so that an unexpected unfavorable outcome of one investment or undertaking will represent only a small portion of all investments or undertakings and so that unfavorable outcomes on some investments or undertakings will be offset by favorable outcomes on other investments or undertakings. Labor strikes typically are peculiar to a particular undertaking, plant, firm or industry and are, therefore, diversifiable by having labor forces in other undertakings, plants, or industries.

The overall objective of accounts receivable management is to: a. Maximize sales. b. Minimize credit losses. c. Maximize profits. d. Minimize uncollectible accounts.

c. Maximize profits

Company specific risk is also known as which one of the following? a. Market-related risk. b. Business risk. c. Unsystematic risk. d. Non-diversifiable risk.

c. Unsystematic risk. Company specific risk (also called firm-specific risk and diversifiable risk) are unsystematic risk. This risk includes those elements of business risk that can be eliminated through diversification. Specifically, this risk can be mitigated by diversification of projects, investments, etc.

The following account balances were taken from Spector Co.'s balance sheet at December 31 of the current and previous years: Current yearPrevious year Cash$ 20,000 $ 10,000 Accounts receivable300,000 310,000 Inventory120,000 130,000 Short-term notes receivable60,000 50,000 Plant and equipment600,000 540,000 Bond sinking fund200,000 190,000 Current liabilities300,000 250,000 Which of the following statements regarding the current ratio and working capital is correct? a. The current ratio increased in the current year. b. Working capital increased in the current year. c. Working capital decreased in the current year. d. The current ratio is the same in the current year as it was in the previous year.

c. Working capital decreased in the current year. Correct! Both the current ratio (also known as the working capital ratio) and working capital are measures of the relationship between current assets and current liabilities. The current ratio (or working capital ratio) measures the relative relationship between current assets and current liabilities in terms of the number of times current assets can cover current liabilities; it is computed as: Current ratio = Current assets / Current liabilities. Working capital measures the absolute dollar amount of the relationship between current assets and current liabilities and is computed as: Working capital = Current assets - Current liabilities. In the account balances given for Spector, current assets and current liabilities consist of the following accounts, with the amounts shown: AccountsCurrent yearPrevious YearCash$ 20,000 $ 10,000 Accounts receivable300,000 310,000 Inventory120,000130,000Short-term notes receivable60,00050,000Total Current Assets$ 500,000$ 500,000Current Liabilities$ 300,000$ 250,000 The computed current ratio and working capital are: Current ratio: Current year $500,000 / $300,000 = 1.666 Previous year $500,000 / $250,000 = 2.000 Working capital: Current year $500,000 − $300,000 = $200,000 Previous year $500,000 − $250,000 = $250,000 Thus, working capital decreased between the previous year and the current year from $250,000 to $200,000.

A cash management system should be concerned with the float associated with both cash receipts and cash disbursement. Will efficient practices seek to increase or decrease receipt float and disbursement float? a. increase receipt float; increase disbursement float b. increase receipt float; decrease disbursement float c. decrease receipt float; increase disbursement float d. decrease receipt float; decrease disbursement float

c. decrease receipt float; increase disbursement float Float is the length of time between the writing of a check (or other draft instrument) and the actual transfer of the funds. Receipt float is the time between the writing of a check (or other instrument) by a customer and when those funds become available to the party to which the check was made. Disbursement float is the time between the writing of a check by a firm writes and removal of the funds from the firm's account. Efficient cash management will seek to decrease receipt float and increase disbursement float. By reducing receipt float, a firm has cash it is receiving available sooner than it would be available otherwise. By increasing disbursement float, a firm has cash it is paying available longer than it otherwise would be available. Thus, decreasing receipt float and increasing disbursement float make more cash available to a firm.

A firm with cash in excess of its immediate needs is considering a temporary investment in newly issued 10-year treasury obligations, which pay a fixed rate of interest. If the investment will be for one year, which of the following risks, if any, would be of concern? a. default risk and interest risk b. default risk only c. interest risk only d. neither default risk nor interest risk

c. interest risk only Debt obligations of the U.S. government are considered to be free of the risk of default, therefore risk of default on the debt would not be of concern. Interest rate risk would be of concern. Interest rate risk derives from the effects on market value resulting from changes in the rate of interest in the market. If the interest rate increases relative to the rate at the time the fixed-rate Treasury obligations are acquired, the market value of the Treasury obligations will decrease (and vice versa). Furthermore, the longer the maturity of the fixed-rate obligations, the greater the influence of a given interest rate change on current market value. Since the Treasury obligation is to be sold in one year, not held to maturity, the value of the obligations at the date of sale will depend on the market interest rate at that time relative to the rate when the obligations are acquired.

preauthorized debit/credit card charges

cash is collected by a charge to a debit or credit card that has been authorized in advance. A bank is not a party in the authorization agreement.

preauthorized checks

cash is collected through checks that re authorized in advance. Such an arrangement would be especially appropriate for firm to consider when its customers pay a fixed amount each period for many periods.

traditional materials requirement planning system (MRP)

characterized by: 1. supply push 2. inventory buffers 3. production characteristics 4. supplier/purchases characteristics 5. quality management 6. accounting issues

monitoring accounts receivable

collection management needs to monitor accounts receivable in the aggregate and individually. Assessment of total accounts receivable is done with averages and ratios such as: 1. average collection period 2. day's sales in accounts receivable 3. accounts receivable turnover 4. accounts receivable to current or total assets 5. bad debt to sales

US treasury bills

considered virtually risk-free, these direct obligations of the US Government are available in increments of $5,00 with a minimum $10,000 investment. With maturities of 3 months, 6 months, and 1 year, they are periodically available directly through federal reserve banks and they are continuously available in the secondary market 1. safety of prinicpal 2. price stability if heels to short maturity 3. marketability/liquidity

commercial paper

consists of short-term unsecured promissory notes issued by large, established firms with high credit ratings. available in several denominations, either directly from the issuing firm or dealers, and can be purchased with maturities from a few days up to 270 days. secondary market is limited and usually restricted to dealers provides a yield greater than other short-term instruments with comparable risk but usually sill less than the prime rate of interst

determining customer creditworthiness and setting credit limits

critical to recognize that the objective is to maximize profits, not to minimize credit losses

working capital ratio

current ratio Measures the quantitative relationship between current assets and current liabilities in terms of the "number of times" current assets can cover current liabilities. It is computed as: Working Capital Ratio (WCR) = Current Assets / Current Liabilities widely used measure of a firm's ability to pay its current liabilities

Bobcat Company has a current ratio of 2:1. If Bobcat has current liabilities of $120,000, which one of the following is the amount of Bobcat's current assets? a. $ 60,000 b. $120,000 c. $180,000 d. $240,000

d. $240,000 The current ratio is computed as current assets (CA) divided by current liabilities (CL). Therefore, a current ratio of 2:1 states that the current assets are 2 times current liabilities. Using the current ratio formula to solve for current assets would show: CR =CAor 2 =CACL$120,000 or CA = $120,000 x 2 = $240,000 The $240,000 in current assets can be confirmed by: CA=$240,000= 2:1 CRCL$120,000

A company has $1,500,000 in current assets and $500,000 in current liabilities. The company's current inventory level is $250,000, and it plans to issue short-term debt to increase inventory. What is the largest amount of short-term debt the company may issue to increase inventory without dropping the current ratio below 2.0? a. $125,000 b. $250,000 c. $375,000 d. $500,000

d. $500,000 The current ratio is calculated as current assets divided by current liabilities. Thus, the company's current ratio before acquisition of additional inventory is: $1,500,000/$500,000 = 3. The acquisition of additional inventory using short-term debt will increase both current assets (inventory) and current liabilities (short-term debt payable). Therefore, the effect of each possible given answer amount can be determined by adding the amount to the numerator and denominator and determining the resulting current ratio to find the amount that results in a current ratio equal to or greater than 2. This correct answer is calculated as: ($1,500,000 + $500,000) / ($500,000 + $500,000) = $2,000,000 / $1,000,000 = 2.0 No greater amount of short-term debt could be incurred and still have a current ratio that is not less than 2.0. [NOTE: If it is assumed that one answer choice will result in a current ratio exactly equal to 2.0 (not a specific outcome given in the facts), the question can be solved with the following algebraic equation: ($1,500,000 + X / $500,000 + X) = 2.]

A firm has daily cash receipts of $100,000 and collection time of 4 days. A bank has offered to reduce the collection time on the firm's deposits by 2 days using a lock-box arrangement for a monthly fee of $500. If money market rates are expected to average 6% during the year, the net annual benefit or cost from having this service is a. $ 3,000 b. $12,000 c. $0 d. $ 6,000

d. $6,000 The gross annual benefit from the lock=box arrangement would be the $100,000 collected per day times 2 days reduced collection time multiplied by the interest received on the accelerated collections. That calculation is: ($100,000× 2)× .06 = $200,000× .06 = $12,000 savings. The gross annual cost of the lock-box arrangement is the $500 per month multiplied by 12 months. The net annual benefit is $12,000 savings - $6,000 cost = $6,000 net benefit.

As a consequence of finding a more dependable supplier and adopting just-in-time inventory ordering, Dee Co. reduced its safety stock of raw materials inventory by 80%. Which one of the following would the reduction in safety stock have on Dee's economic order quantity? a. 80% decrease. b. 64% decrease. c. 20% increase. d. 0% change (no effect).

d. 0% change ( no effect) A change in safety stock does not affect a firm's economic order quantity (but does affect its reorder point). The calculation of economic order quantity (EOQ) is: sq rt ((2 X annual demand x cost per order)/carrying cost per unit) Thus, the safety stock is not a factor in determining the economic order quantity, and a change (decrease) in safety stock would have no effect on Dee's economic order quantity.

A company has income after tax of $5.4 million, interest expense of $1 million for the year, depreciation expense of $1 million, and a 40% tax rate. What is the company's times-interest-earned ratio? a. 5.4 b. 6.4 c. 7.4 d. 10.0

d. 10.0 The company's times-interest-earned ratio is 10.0. The times-interest-earned ratio measures the ability of current earnings to cover interest payments for a period. It is measured as: Times-Interest-Earned Ratio = (Net Income + Interest Expense + Income Tax Expense) / Interest Expense Therefore: Times-Interest-Earned Ratio = ($5.4M + $1M + $3.6M*)/$1M= $10M/$1M = 10.0 times Income before taxes is computed as: .6X = $5.4M (i.e., 60% of taxable income equals $5.4M). Therefore: X (income before taxes) = $5.4M/.6 = $9.0M. Income before taxes = $9.0M - income after taxes = $5.4M = income taxes = $3.6M.) The $10M also can be determined as $9.0 income before taxes + $1M interest expense= $10M.

Selected data pertaining to Lore Co. for the calendar year 2003 is as follows: Net cash sales$ 3,000 Cost of goods sold18,000 Inventory at beginning of year6,000 Purchases24,000 Which one of the following was Lore's average days' sales in inventory? a. 3 days b. 6 days c. 25 days d. 180 days

d. 180 days The average days' sales in inventory is calculated as: 360 days/Inventory Turnover.Inventory Turnover = COGS/Average InventoryIn this problem, average inventory is BI = $6,000 + EI = $12,000 = $18,000/2 = $9,000.The EI is BI = $6,000 + Purchases = $24,000 = $30,000 - COGS = $18,000 = $12,000.Therefore, inventory turnover is COGS = $18,000/Avg Inven = $9,000 = 2.Then, 360/2=180.

A corporation manages inventory performance by monitoring its inventory turnover. Selected financial records for the corporation are as follows: Year 1Year 2Year 3Annual sales$1,262,500$1,062,500$1,459,000Gross annual profit percentage45%30%40% The beginning finished goods inventory for year 2 was 20% of year 2 sales. The ending finished goods inventory for year 2 was 18% of year 3 sales. What was the corporation's inventory turnover for year 2? a. 1.34 b. 2.83 c. 3.03 d. 3.13

d. 3.13 Inventory turnover measures the number of times that inventory is acquired and sold or used during a period. It is calculated as: Cost of Goods Sold/Average Inventory (i.e., beginning inventory + ending inventory/2). In this question, the cost of goods sold is determined using the inverse of the gross annual profit percentage (which is the gross annual cost percentage), or $1,062,500 x (1.0 - .30) = $1,062,500 x .70 = $743,750, the cost of goods sold. The average inventory is determined using the percentage of sales that constitutes inventory as give in the facts. Specifically, year 2 beginning inventory is $1,062,500 x .20 = $212,500 and year 2 ending inventory is $1,459,000 x .18 = $262,620. The average is the sum of beginning plus ending divided by 2, or $212,500 + 262,620 = $475,120/2 = $237,560, the average inventory. Therefore, the inventory turnover is: $743,750/$237,560 = 3.13 - the inventory turned over 3.13 times during year 2.

The following calculations were made from Clay Co.'s Year 1 books: Number of days' sales in inventory61 DaysNumber of days' sales in trade accounts receivable33 Days Which one of the following was the number of days in Clay's Year 1 operating cycle? a. 33 days b. 47 days c. 61 days d. 94 days

d. 94 days The operating cycle measures the average length of time to invest cash in inventory, convert the inventory to accounts receivable, and collect the receivables. Thus, for Clay, its operating cycle is the sum of its number of days' sales in inventory plus the number of days' sales in trade accounts receivable, or 61 days + 33 days = 94 days. Basically, this measures the number of days to go from cash through inventory and accounts receivable, back to cash.

Which of the following ratios would most likely be used by management to evaluate short-term liquidity? a. Return on total assets. b. Sales to Cash. c. Accounts receivable turnover. d. Acid test ratio.

d. Acid test ratio The acid test ratio (also called the quick ratio) is a measure of an entity's short-term liquidity. It measures the number of times that cash and assets that can be converted quickly to cash cover current liabilities. It is computed as: Acid Test Ratio = (Cash + Net Receivables + Marketable Securities) / Current Liabilities

Which of the following statements concerning working capital management is/are correct? I. A firm can be over invested in net working capital.II. A firm can be under invested in net working capital. a.Neither I nor II. b. I only. c. II only. d. Both I and II.

d. Both I and II A firm may be either over invested or under invested in net working capital. If over invested in net working capital, typically it will earn a lower return than would be possible if the assets were invested in capital projects. If under invested in net working capital, a firm maybe unable to meet current operating and financial needs, including having inadequate cash, and incurring inventory shortages.

All other things being equal, which one of the following types of investment securities would be expected to have the highest yield (return)? a. U.S. Treasury bills b. Municipal bonds c. Federal agency securities d. Corporate bonds

d. Corporate bonds Since corporate bonds are more risky than U.S. Treasury bills and Federal agency securities, and since the interest they pay is taxable, they would be expected to have the highest yield.

Asher Company eased its credit policy by lengthening its discount period from 10 days to 15 days. Which of the following is/are likely reasons for Asher lengthening its discount period? I. To show a higher average age of accounts on its accounts receivable aging schedule. II. To meet terms offered by competitors. III. To seek to stimulate sales. a. I only. b. II only. c. III only. d. II and III, only.

d. II and III only

When making short-term investments, which one of the following is the risk associated with the ability to sell an investment in a short period of time without having to make significant price concessions? a. Purchasing power risk. b. Interest rate risk. c. Default risk. d. Liquidity risk.

d. Liquidity risk The risk associated with the ability to sell an investment in a short period of time without having to make significant price concessions is liquidity risk. Two possible elements are implied in the risk: (1) the inability to sell for cash in the short term, and (2) the inability to receive fair value in cash in the short term.

Which of the following statements concerning ratio analysis is/are correct? I. Ratio analysis uses only monetary measures for analysis purposes. II. Ratio analysis uses only measures from financial statements for analysis purposes. a. I only. b. II only. c. Both I and II. d. Neither I nor II.

d. Neither I nor II Ratio analysis uses monetary measures as well as other quantitative measures. For example, in the earnings per share calculation, the number of shares of common stock, a non-monetary measure, is used. Ratio analysis also uses financial statement measures in addition to measures that are not a part of financial statements. For example, the price-earnings ratio uses the market price of the stock, a measure not found in the financial statements.

Which of the following is least likely to be a major purpose or type of ratio or measure used in financial management? a. Solvency. b. Operational activity. c. Price indexes. d. Liquidity.

d. Price indexes Price indexes convert prices of one period to what those prices would have been in terms of prices of a prior period. They are not a major purpose or type of measure used in working capital management. Common examples of price indexes are the consumer price index (CPI) and the producer price index (PPI).

Which one of the following would not be considered an element of concern in working capital management? a. Accounts receivable. b. Inventory. c. Accounts Payable. d. Property, plant, and equipment.

d. Property, plant, and equipment Property, plant, and equipment is not an element of working capital. Although management of property, plant, and equipment would be a management concern, it would not be a factor in the management of working capital, which is comprised of current assets and current liabilities.

A company has several long-term floating-rate bonds outstanding. The company's cash flows have stabilized, and the company is considering hedging interest rate risk. Which of the following derivative instruments is recommended for this purpose? a. Structured short-term note. b. Forward contract on a commodity. c. Futures contract on a stock. d. Swap agreement.

d. Swap agreement. A swap agreement would be recommended to hedge interest rate risk on long-term floating-rate bonds. In an interest rate swap agreement one stream of future interest payments (e.g., floating-rate payments) is exchanged for another stream of future interest payments (e.g., fixed-rate payments) for a specified principal amount. In this case, an interest rate swap would hedge (mitigate) exposure to fluctuations in interest rates of the floating-rate bonds by exchanging those payments for a fixed-rate payment

Which one of the following short-term investments is likely to provide the greatest safety of principal? a. Commercial paper. b. Bankers' acceptance. c. Fannie Mae securities. d. U.S. Treasury bills.

d. U.S. Treasury bills Treasury Bills are debt obligation of the U.S. government, have a maturity of one year or less, and are backed by the full faith and credit of the U.S. government. Treasury Bills are considered the safest securities available to the U.S. investor.

a decrease in current assets (alone)

decreases the WCR

an increase in current liabilities (alone)

decreases the WCR

nature of credit sales documentation

determines the form of documentation to be required from customers at the time they purchase on account.

reorder point

determines the inventory quantity at which goods should be reordered reorder point = delivery time stock + safety stock

penalty for late payment

determines the penalty to be assessed if customers don't pay by the final due date, including the length of any "stretch" period before the penalty applies the penalty should at least cover the cost of financing the account receivable for the overdue period

international receivables

differences in law, cultures and customs may increase uncertainty as to the timing and/or collectibility of amounts due. These difference call for special consideration such as: 1. collection in advance 2. open-account sales 3. mitigating foreign collection problems

return on assets

divide net income / assets

if the WCR exceeds 1.00 then

equal increases in current assets and liabilities decrease the WCR equal decreases in current assets and liabilities increase the WCR

If the WCR is less than 1.00 then

equal increases in current assets and liabilities increase the WCR equal decreases in current assets and liabilities decrease the WCR

total credit period

established the maximum period for which credit is extended. the length of the credit period relates to the durability of goods sold

inventory management and control

facilitated by the use of certain ratios including: 1. inventory turnover 2. number of days' sales in inventory

hedging with forward and futures

forward and futures contracts can be used to acquire a security (hedging instrument) whose price also moves with changes in the interest rate, but moves in the opposite direction as that of the item being hedged (hedged item). As a consequence of holding both items, the changes in the prices of the two items caused by changes in the market rate of interest offset each other (at least in part).

collection in advance

generally, not a reasonable expectation when making foreign sales. Such customers are not comfortable with prepaying for goods or services not yet received.

Establishing General Terms of Credit

if sales are to be made on credit, the firm must establish the general terms under which such sales will be made. To a certain extent, for competitive reasons the terms of sale adopted by a firm will need to approximate terms established in its industry specific terms of sale decisions to be made include: 1. total credit period 2. discount terms for early payment 3. penalty for late payment 4. nature of credit sales documentation

not over invest

in net working capital (assets) which provide low returns or increase costs, for example: 1. excess idle cash- which has a low rate of retune if any 2. excess accounts receivable- which do not earn interest

an increase in current assets (alone)

increase the WCR

a decrease in current liabilities (alone)

increases the WCR

remote disbursing

intended to increase the float on checks used to pay obligations. By increasing the float, cash is available longer to the paying firm. It is accomplished by establishing checking accounts in remote locations and paying bills with checks drawn on those accounts.

meet ongoing operation and financial needs of the firm

inventory- to meet production requirement cash- to meet obligation as they come due

marketability/liquidity

investments should be in instrument that have a ready market for converting securities to cash without incurring undue cost

safety of principal

investments should have little risk of default by the issuer. Default risk is a measure of the likelihood that the issuer will not be able to make future interest and/or principal payments to a security holder. Temporary investments should be in securities with a low risk of default

Negotiable certificates of deposit

issued by banks in return for a fixed time deposit with the bank. pay a fixed rate of interest and are available in a variety of denominations and maturities. can be bought and sold in a secondary market. high safety of principal and relatively short-term stability

permanent amount of financing

just as some amount of current assets is a permanent use of financing, some amount of current liabilities provides a permanent amount of financing

Sharpe ratio

measures how well the average return on an investment compensates for the risk of the investment; it can be thought of as a measure of the excess return (reward) per unit of risk = (AR-RR)/SD AR= average rate of return of investment RR = average risk-free rate o return SD= standard deviation of investment average return The greater the investment's sharpe ratio, the better its risk-adjusted performance. A negative ratio indicates that an investment with no risk would perform better than the investment being analyzed

positive pay systm

offered by banks as a means of fraud detection for an entity's checking accounts 1. an entity electronically transmits to its bank a file for the checks it has issued. That file contains the entity's account number, check issue dates, check numbers, and check amounts for all checks written 2. when the entity's checks are presented at the bank for payment, they are compared electronically against the list provided by the entity 3.If the elements of a check do not exactly match the file presented by the issuing entity, the bank treats the check as an exception item that is held until the issuing firm is contacted. 4. The bank provides the issuing firm, either electronically or by fax, information about the exception item. 5. The issuing firm can then either approve payment of the item or return the check through the banking system.

coefficient of variation

one measure used to access the risk-reward relationship (for either short-term or long-term investments) is the coefficient of variation the measure of the relative variability of return values around the mean return; it can be thought of as a measure of the total risk per unit of return

risk-reward relationship

reflects that the greater the perceive risk inherent in an opportunity, the greater the reward expected from an investment in the opportunity

credit-rating service

reports from these agencies provide considerable information about a potential credit customer, including a score that reflects relative creditworthiness. such scores can be used in both making the credit decision and in establishing a credit limit.

Cash objective

since cash provides little or no return (and will lose real value during inflation) firms seek to maintain a minimum cash balance consistent with meeting its debt and other obligations as they come due. Holding too much cash will result in loss of return to the firm

management of net working capital

sufficient net working capital must be maintained to avoid the risk of interrupting operations and the ability to meet current obligations, but over-investment in net working capital reduces the rewards, which could be recognized by the firm through investment in assets with greater returns

Just-in-Time inventory system

the basis of the system is obtaining and delivering inventory just as or only when it is needed. characterized by: 1. demand pull 2. inventory reduction 3. production characteristics 4. supplier/purchases characteristics 5. quality management 6. accounting issues

Deferring and controlling cash outflows

the central objectives of deferring and controlling cash outflows are to make cash available to the firm for a longer period and to control cash disbursements

discount terms for early payment

the combination of the discount rate and period will determine the effective interest rate associated with the discount offered which, in turn, will determine the effectiveness of the discount policy 2/10, n/30 = 2% discount if paid within 10 days

Working capital

the difference between a firm's current assets and its current liabilities working capital = current assets - current liabilities

lockbox system

the firm leases post office boxes in areas where it has high volume of payments through the mail. Customers remit payment to those post office boxes. The firm's bank collects the remittances from the lockboxes and processes and deposits the checks directly to the firm's account(s). The bank then notifies the firm of the sources and amounts collected so that the firm can update its cash and receivables accounts. A lockbox arrangement may reduce the float from seven (or more) days to two or three days

repurchase agreements (repo)

the firm makes an investment and simultaneously enters into a commitment to resell the security at the original contract price plus an agreed interest income for the holding period usually for large denominations and have agreement specific maturities yield is usually less than treasury bill but may offer advantages o liquidity and very short maturity

disadvantages of payments by daft

they typically involve a fee that may make their use relatively expensive compared to payment by check

central issue in inventory management

to determine and maintain an optimum investment in all inventories. for manufacturing firms that includes raw materials, work-in-process, and finished goods for retail firm its goods for resale

Objectives in managing working capital

to maintain adequate working capital in order to: 1. meet ongoing operation and financial needs of the firm 2. not overinvest

objective in investment assessment

to minimize the risk associated with the investment while seeking to earn a competitive rate of return.

debt to equity ratio

total debt (liabilities) / Owner's equity

zero balance accounts

use is based on an agreement between the firm and a bank under which the firm has accounts with no real balance. Under one arrangement checks written on these accounts are processed as usual, resulting in overdrawn accounts, but by agreement with the bank these overdrafts are covered automatically by transfers from a master account. At the end of the day these accounts have no balance or after a firm determines an amount to be paid from an account, an amount equal to the payments is deposited into the accounts. Therefore, the account has no real balance since outstanding checks are exactly equal to the account balance

concentration banking

used to accelerate the flow of cash to a firm's principal bank. That flow is achieved by having customers remit payment and company units making deposits to banks close to their locations. The funds collected in the multiple local bank accounts are transferred regularly, and often automatically, to the firm's account in its primary (or concentration) bank

depository transfer checks/official bank checks

used to transfer funds between a firm's accounts. Depository transfer checks are unsigned, non-negotiable, and payable only to an account of the firm. For example, in a manual system, at the time a unit of the firm makes a deposit at a local bank, it also prepares and sends a depository transfer check to its principal (and perhaps, concentration) bank. The receiving bank deposits the funds to the firm's account and processes the depository check back to the local bank where funds were deposited by the firm's unit. As an alternative to traditional processing of depository transfer checks, an automated system exists which transmits the deposit information electronically to the principal bank where the actual check is prepared and processed, and the funds deposited to the firm's account. Under either the traditional or the automated process, funds normally are not available for the firm to use until the depository transfer check actually clears the local bank.

Temporary excess cash

when a firm has temporary excess cash, it should invest those funds so as to earn a return greater than would be provided by "idle cash"

if the WCR equals 1.00, equal increases or equal decreases in current assets and liabilities

will not change WCR; it will remain 1.00

the nature of the environment

would include the general economic conditions (e.g., as reflected by business cycles), competition, customer demand, technology, and other major elements of the environment in which the firm operates

the nature of the firm

would include the kind of products and services it provides, its cost structure, its financial structure, and all the other elements that make up the total firm, including the specific kinds of risk inherent in the firm

risk

—Risk is the possibility of loss or other unfavorable outcome that results from the uncertainty in future events. Entities face a variety of different kinds of economic risk as they carry out their operating and financing activities.

cash conversion cycle

—The (average) period of time between when cash is paid to suppliers (e.g., for inventory) and when cash is collected from customers (including the time to collect accounts receivable, if sales are made on account); it measures the time to go from "cash-back to-cash." Notice that: The actual cash outflow and inflow establish the start and end of the cash conversion cycle. CCC = inventory conversion cycle + accounts receivable conversion cycle - accounts payable conversion cycle CCC = operating cycle - accounts payable conversion cycle If any three of the four conversion cycles are known, the fourth conversion cycle can be determined

accounting issues

—Traditional cost accounting is used with emphasis on job order and processing cost approaches. Multiple inventory accounts are used. Accounting involves complex cost accumulation and allocations, including setting standards, allocating costs, variance analysis and reporting.