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55 Cards in this Set
- Front
- Back
Working Capital |
Current assets used in operations |
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Net Working Capital |
Current assets - current liabilities |
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2 Questions of working capital management |
1. What is the correct amount of working capital? 2. How should working capital be financed? |
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What does not having enough working capital do? |
Adversely affects ability to generate sales and profits |
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Cash Conversion Cycle (CCC) |
Cycle of purchasing inventory, selling goods on credit, and collecting A/R. |
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What does CCC focus on? |
The time between a company making payments and receiving cash |
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What does a shorter CCC mean? |
The company is collecting cash faster and needs less money to finance working capital |
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CCC = |
Inventory Conversion Period + Receivables Collection Period - Payables Deferral Period |
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Inventory Conversion Period |
Inventory/(Sales/365) How many days it takes to sell inventory |
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Receivables Collection Period |
Receivables/(Sales/365) also known as DSO How many days to convert A/R to cash
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Payables Deferral Period |
Payables/(COGS/365) How many days it takes to pay for purchases |
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How can you lower CCC? |
1. Reduce amount of inventory needed 2. Reduce amount of A/R needed 3. Increase time it takes to pay suppliers |
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Relaxed Working Capital Policy |
- Large amount of cash and inventories carried - Sales stimulated by generous credit policy - Large amount of A/R |
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What does a relaxed working capital policy result in? |
Lower returns, lower risk |
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Restricted working capital policy |
Amount of cash, inventories, and A/R are minimized |
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What does a restricted working capital policy result in? |
Higher return, greater risk |
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Moderate working capital policy |
Between the extremes |
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When would a company only keep a minimal amount of working capital on hand? |
When business conditions are fairly certain |
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Cyclical fluctuations |
Seasonal business peaks |
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How should businesses handle cyclical fluctuations? |
Build up net working capital around sales peak, then decrease it during slow sales season |
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Permanent net working capital |
Minimum amount of working capital a company maintains at the slow points |
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Temporary net working capital |
Working capital added as sales grow seasonally |
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Short term financing policy |
How permanent and temporary net working capital is financed |
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Maturity Matching (self liquidating) approach |
Matching asset and debt maturities Firm uses financing tool with same life as the asset |
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What does the maturity matching approach minimize? |
Risk that the firm won't be able to pay off its financing |
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Aggressive approach |
Financing a firms long term assets with long term capital and part of its net working capital with short term debt |
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Why is the aggressive approach aggressive? |
Firms can borrow short term for cheaper, meaning higher profits and greater risk |
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Conservative approach |
Financing fixed assets with net working capital and some (or all) temporary NWC with long term capital |
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Why is the conservative approach conservative? |
It's more expensive and safer |
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Pros of short term debt |
-Easier to get -Good for seasonality of business -Interest rates are lower |
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Cons of short term debt |
-Risky -Interest rates vary -Debt may not be renewed |
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Trade Credit |
- A/P - Spontaneous form of financing. A/P grow with company. |
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Terms of Credit |
Credit policy Ex. 2/10 net 30 |
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What is the true price if a trade credit is involved? |
True price is the cost of good after the discount |
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Nominal annual cost |
Calculates cost of forgoing trade discount |
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Kdis = d%/100-d% x 365/f(date) - d(date) |
Nominal annual cost |
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What do lenders look at 1st and 2nd as forms of repayment for loans? |
1. EBIT and EBITDA 2. Amount/type of asset for collateral |
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Prime rate |
Lowest interest rates Bank saves for best customers Attainable by larger stable firms |
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Fixed interest rate |
Set for loan term |
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Floating interest rate |
Change as primary rate changes |
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Interest only loans |
Payments made during life of loan only include interest Principal is paid on maturity |
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Installment Loans |
Payments consisting of both interest and principal |
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Line of Credit |
Short term loan used to finance seasonal working capital. Borrow only borrows what they need. |
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Commercial Paper |
Short term unsecured promissory note issued by large companies |
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Bankers Acceptance |
Term drafts issues by corporations - guaranteed by major banks |
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3 types of short term loans |
1. Interest only 2. Line of credit 3. Installment loans |
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Installment loans |
Principal and interest paid in equal instalments of loans life |
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3 Money Market Securities |
1. Commercial paper 2. Bankers acceptance 3. Treasury bills |
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Yield = 100 - P/P x 365/d |
Annualized return on money market securities Yield = 100 - discounted price as % of par value/discounted price as % of par value x 365/ number of days til maturity |
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Pledging A/R |
A/R used as security for loan lender has claim against receivables and borrower |
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Factoring |
Borrower sells A/R to factoring company and receives discounted payment upfront |
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Factoring with recourse |
Allows factor to resell receivable back to company if it's uncollectible |
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Inventory blanket lien |
Lender has claim against all inventory Few restrictions on inventory maintenance |
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Trust receipt |
Specific inventory is held for lender Inventory is segregated |
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Warehouse receipt financing |
Inventory is secured by 3rd part (segregated) |