Chapter 15 pg 554
short-term debt is riskier to the borrowing firm for two reasons: (
(1) If a firm borrows on a long-term basis, its interest costs will be relatively stable over time. But if it uses short-term credit, its interest expense can fluctuate widely, perhaps reaching such high levels that profits are extinguished. (2) If a firm borrows heavily on a short-term basis, a temporary recession may adversely affect its financial ratios and render it unable to repay this debt.
Note that a firm's marketable security holdings can be divided into two categories:
(1) Operating short-term securities, which are held primarily to provide liquidity and are bought and sold as needed to provide funds for operations, and (2) other short-term securities, which are holdings in excess of the amount needed to support normal operations.
Name some key features Promissory Note:
1. Amount 2. Maturity 3. Interest rate 4. Interest only versus Amortized 5. Frequency of interest payments 6. Discount interest 7. Add- on loans 8. Collateral 9. Restrictive covenants 10. Loan Guarantees
15-8A CREDIT POLICY pg 573
1. Credit Period 2. Discounts 3. Credit Standards 4. Collection Policy
Two types of Free Credit:
1. Free Trade Credit 2. Costly Trade Credit
The following techniques are used to optimize demand deposit holdings:
1. Hold marketable securities rather than demand deposits to provide liquidity 2. Borrow on short notice 3. Forecast payments and receipts better 4. speed up payments 5. use credit cards, debits cards, wire transfers and direct deposits. 6. synchronize Cash flows
Graph on pg 557
1. Relaxed Investment Policy 2. Restricted Investment Policy 3. Moderate Investment Policy
Line of Credit/Credit Line
A bank loan agreement that provides immediate short-term access to cash.
Maturity Matching or Self Liquidating Approach
A financing policy that matches the maturities of assets and liabilities. This is a moderate policy.
15-10B LINE OF CREDIT pg 580
A line of credit is an agreement between a bank and a borrower indicating the maximum amount of credit the bank will extend to the borrower
conservative approach
A policy under which all of the fixed assets, all of the permanent current assets, and some of the temporary current assets of a firm are financed with long-term capital.
prime rate
A published interest rate charged by commercial banks to large, strong borrowers.
15-10C REVOLVING CREDIT AGREEMENT pg 581
A revolving credit agreement is a formal line of credit. A formal, committed line of credit extended by a bank or other lending institution.
15-5 The Cash Budget pg 565
A table that shows cash receipts, disbursements, and balances over some period.
15-4 The Cash Conversion Cycle pg 561
All firms follow a "working capital cycle" in which they purchase or produce inventory, hold it for a time, and then sell it and receive cash. This process is similar to the Yankee peddler's trips, and it is known as the cash conversion cycle (CCC).
15-3A MATURITY MATCHING, OR "SELF-LIQUIDATING," APPROACH pg 558
All of the fixed assets plus the permanent current assets are financed with long-term capital, but temporary current assets are financed with short-term debt
15-8 Accounts Receivable pg 573
Although some sales are made for cash, today the vast majority of sales are on credit. Thus, in the typical situation, goods are shipped, inventories are reduced, and an account receivable is created.1
Accounts Receivable
Amounts to be received in the future due to the sale of goods or services 1. Credit Policy
moderate investment policy
An investment policy that is between the relaxed and restricted policies.
Investments in current assets must be financed; and the primary sources of funds
Bank loans, credit from suppliers (accounts payable), accrued liabilities, long-term debt, and common equity
15-3D CHOOSING BETWEEN THE APPROACHES pg 560
Because the yield curve is normally upward sloping, the cost of short-term debt is generally lower than that of long-term debt. However, short-term debt is riskier to the borrowing firm for two reasons:
costly trade credit pg 578
Credit Taken in excess of free trade credit whose costs is equal to the discount lost.
15-8B SETTING AND IMPLEMENTING THE CREDIT POLICY pg 574
Credit policy is important for three main reasons: (1) It has a major effect on sales. (2) It influences the amount of funds tied up in receivables. (3) It affects bad debt losses.
permanent current assets
Current assets that a firm must carry even at the trough of its cycles.
temporary current assets
Current assets that fluctuate with seasonal or cyclical variations in sales.
Trade Credit
Debt arising from credit sales and recorded as an account receivable by the seller and as an account payable by the buyer
4. collection policy
Degree of toughness in enforcing the credit terms
currency
Fast-food operators, casinos, hotels, movie theaters, and a few other businesses hold substantial amounts of currency, but the importance of currency has decreased over time due to the rise of credit cards, debit cards, and other payment mechanisms.
15-9 Accounts Payable (Trade Credit) pg 576
Firms generally make purchases from other firms on credit and record the debt as an account payable. . Accounts payable, or trade credit, is the largest single category of short-term debt, representing about 40% of the average corporation's current liabilities.
restricted investment policy
Holdings of cash, marketable securities, inventories, and receivables are constrained.
15-7 Inventories pg 572
Inventories, which can include (1) supplies, (2) raw materials, (3) work in process, and (4) finished goods, are an essential part of virtually all business operations.
15-6C MARKETABLE SECURITIES pg 570
Marketable securities held for operations are managed in conjunction with demand deposits—the management of one requires coordination with the other.
Credit scores
Numerical scores that indicate the likelihood that people or businesses will pay on time.
Lockboxes
Post office boxes operated by a bank to which payments are sent. Use to speed up effective receipt of cash.
2. Discounts
Price reductions given for early payment
relaxed investment policy
Relatively large amounts of cash, marketable securities, and inventories are carried, and a liberal credit policy results in a high level of receivables.
credit terms
Statement of the credit period and discount policy.
Payables Deferral period
The average length of time between the purchase of materials and labor and the payment cash for them 40 days to repay in credit
Average collection Perido (ACP)
The average length of time required to convert the firms receivables into cash, that is, to collect cash following a sale. 60 days given to customers to pay
Inventory Conversion Period
The average time required to convert raw materials into finished goods and then to sell them. 60 day period to sell
Target Cash Balance
The desired cash balance that a firm plans to maintain in order to conduct business.
3. credit standards
The financial strength customers must exhibit to qualify for credit
Cash Conversion Cycle (CCC)
The length of time funds are tied up in working capital, or the length of time between paying for working capital and collecting cash from the sale of the working capital.
What is trade credit?
The practice of buying goods or services now and paying for them later.
15-3B AGGRESSIVE APPROACH pg 558
The reason for adopting the aggressive policy is to take advantage of the fact that the yield curve is generally upward sloping; hence, short-term rates are generally lower than long-term rates.
Net Operating Capital
The sum of net operating working capital and operating long-term assets, such as net plant and equipment. Net operating capital is also called total net operating capital. It is also equal to the net amount of investor-supplied operating capital.
15-1 Background on Working Capital pg 555
The term working capital originated with the old Yankee peddler who would load up his wagon and go off to peddle his wares. The merchandise was called "working capital" because it was what he actually sold, or "turned over," to produce his profits. 1. Working Capital 2. Net Working Capital 3. Net operating working Capital
1. promissory note
The terms of a bank loan are spelled out in a promissory note. A document specifying the terms and conditions of a loan, including the amount, interest rate, and repayment schedule.
15-8C MONITORING ACCOUNTS RECEIVABLE pg 575
The total amount of accounts receivable outstanding at any given time is determined by the volume of credit sales and the average length of time between sales and collections.
15-4A CALCULATING THE TARGETED CCC pg 561
This information can be used to calculate GFI's cash conversion cycle, which nets out the three time periods described below: 1. Inventory Conversion Period 2.Average collection period (ACP) 3. Payable deferral Period
1. credit period
Time period that can pass before a customer's payment is due.
Under what act is illegal to for a firm to charge higher interest or have a preferred firm.
Under the Robinson-Patman Act.
15-6 Cash and Marketable Securities pg 569
When most people use the term cash, they mean currency (paper money and coins) in addition to bank demand deposits. However, when corporate treasurers use the term, they often mean currency and demand deposits in addition to very safe, highly liquid, marketable securities that can be sold quickly at a predictable price, and thus be converted to bank deposits.
Working Capital Management
Working capital management involves finding the optimal levels for cash, marketable securities, accounts receivable, and inventory, and then financing that working capital at the least cost. Effective working capital management can generate considerable amounts of cash.
revolving credit agreement
a line of credit that's guaranteed but usually comes with a fee
Cash and Marketable Securities
come first in the current asset portion of the balance sheet 1. Currency 2. Demand Deposits 3. Marketable securities
free trade credit pg 578
credit received during the discount period
Working Capital
current assets
Net Working Capital
current assets minus current liabilities
Demands Deposits
e deposits are used for transactions—paying for labor and raw materials, purchasing fixed assets, paying taxes, servicing debt, paying dividends, and so forth. However, commercial demand deposits typically earn no interest, so firms try to minimize their holdings while still ensuring that they are able to pay suppliers promptly, take trade discounts, and take advantage of bargain purchases.
who has the final say on credit policy?
executive committee (which normally consists of the president in addition to the vice presidents of finance and marketing) has the final say on setting the credit policy.
Short term loans:
generally be negotiated much faster than long term loans
short-term debt
may offer greater flexibility
15-3 Current Assets Financing Policies pg 558
s. Note, though, that current assets rarely drop to zero—companies maintain some permanent current assets, which are the current assets needed at the low point of the business cycle. Then as sales increase during an upswing, current assets are increased, and these extra current assets are defined as temporary current assets as opposed to permanent current assets. The manner in which these two types of current assets are financed is called the firm's current assets financing policy.
marketable securities
temporary investment of "extra" cash by organizations for up to one year in U.S. Treasury bills, certificates of deposit, commercial paper, or eurodollar loans
Current Assets Financing Policy
the manner in which current assets are financed
Working Capital Gains:
they had to be repaid after each trip to demonstrate that the peddler was solvent and worthy of a new loan.