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55 Cards in this Set

  • Front
  • Back

Working Capital

Current assets used in operations

Net Working Capital

Current assets - current liabilities

2 Questions of working capital management

1. What is the correct amount of working capital?


2. How should working capital be financed?

What does not having enough working capital do?

Adversely affects ability to generate sales and profits

Cash Conversion Cycle (CCC)

Cycle of purchasing inventory, selling goods on credit, and collecting A/R.

What does CCC focus on?

The time between a company making payments and receiving cash

What does a shorter CCC mean?

The company is collecting cash faster and needs less money to finance working capital

CCC =

Inventory Conversion Period + Receivables Collection Period - Payables Deferral Period

Inventory Conversion Period

Inventory/(Sales/365)


How many days it takes to sell inventory

Receivables Collection Period

Receivables/(Sales/365) also known as DSO


How many days to convert A/R to cash


Payables Deferral Period

Payables/(COGS/365)


How many days it takes to pay for purchases

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

Relaxed Working Capital Policy

- Large amount of cash and inventories carried


- Sales stimulated by generous credit policy


- Large amount of A/R

What does a relaxed working capital policy result in?

Lower returns, lower risk

Restricted working capital policy

Amount of cash, inventories, and A/R are minimized

What does a restricted working capital policy result in?

Higher return, greater risk

Moderate working capital policy

Between the extremes

When would a company only keep a minimal amount of working capital on hand?

When business conditions are fairly certain

Cyclical fluctuations

Seasonal business peaks

How should businesses handle cyclical fluctuations?

Build up net working capital around sales peak, then decrease it during slow sales season

Permanent net working capital

Minimum amount of working capital a company maintains at the slow points

Temporary net working capital

Working capital added as sales grow seasonally

Short term financing policy

How permanent and temporary net working capital is financed

Maturity Matching (self liquidating) approach

Matching asset and debt maturities


Firm uses financing tool with same life as the asset

What does the maturity matching approach minimize?

Risk that the firm won't be able to pay off its financing

Aggressive approach

Financing a firms long term assets with long term capital and part of its net working capital with short term debt

Why is the aggressive approach aggressive?

Firms can borrow short term for cheaper, meaning higher profits and greater risk

Conservative approach

Financing fixed assets with net working capital and some (or all) temporary NWC with long term capital

Why is the conservative approach conservative?

It's more expensive and safer

Pros of short term debt

-Easier to get


-Good for seasonality of business


-Interest rates are lower

Cons of short term debt

-Risky


-Interest rates vary


-Debt may not be renewed

Trade Credit

- A/P


- Spontaneous form of financing. A/P grow with company.

Terms of Credit

Credit policy


Ex. 2/10 net 30

What is the true price if a trade credit is involved?

True price is the cost of good after the discount

Nominal annual cost

Calculates cost of forgoing trade discount

Kdis = d%/100-d% x 365/f(date) - d(date)

Nominal annual cost

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

Prime rate

Lowest interest rates


Bank saves for best customers


Attainable by larger stable firms

Fixed interest rate

Set for loan term

Floating interest rate

Change as primary rate changes

Interest only loans

Payments made during life of loan only include interest


Principal is paid on maturity

Installment Loans

Payments consisting of both interest and principal

Line of Credit

Short term loan used to finance seasonal working capital. Borrow only borrows what they need.

Commercial Paper

Short term unsecured promissory note issued by large companies

Bankers Acceptance

Term drafts issues by corporations - guaranteed by major banks

3 types of short term loans

1. Interest only


2. Line of credit


3. Installment loans

Installment loans

Principal and interest paid in equal instalments of loans life

3 Money Market Securities

1. Commercial paper


2. Bankers acceptance


3. Treasury bills

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

Pledging A/R

A/R used as security for loan


lender has claim against receivables and borrower

Factoring

Borrower sells A/R to factoring company and receives discounted payment upfront

Factoring with recourse

Allows factor to resell receivable back to company if it's uncollectible

Inventory blanket lien

Lender has claim against all inventory


Few restrictions on inventory maintenance

Trust receipt

Specific inventory is held for lender


Inventory is segregated

Warehouse receipt financing

Inventory is secured by 3rd part (segregated)