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20 Cards in this Set

  • Front
  • Back

Net Working Capital

NWC = current assets - current liabilities

Why is it hard to estimate of benefit of investments in NWC

1. Not easily measurable


2. Separable returns




Firm's operational goal is to minimize NWC, subject to sufficient NWC available to meet firm's operational needs

Benefit and cost of holding cash

Benefit - facilitates transactions


Cost - foregone opportunity costs

Goals of cash management

1. Reduce the opportunity cost of holding idle cash


2. ensure that all obligations are paid on time


3. Collect money owed as soon as it becomes due.

Four Cs of credit

1. Character


2. Capacity


3. Capital


4. Condition

Tradeoffs of trade credit

1. Opportunity cost of funds tied up in A/R


2. Reduction in revenue


3. Bad Debt




Benefit - impact on sales.

Three elements of inventory cost

1. Ordering cost


2. Carrying (holding cost)


3. Stockout costs

Inventory Management - 4 approaches

1. Economic order quantity (EOQ)


2. ABC Method


3. Materials requirement planning (MRP)


4. Just-in-time (JIT)

Economic order quantity (EOQ)

Determines the optimal order size to minimize total inventory costs (ordering cost + holding cost).




Total ordering costs = total holding cost

ABC Method

Inventory group with the highest value receives the greatest level of management and control.

Material requirement planning (MRP)

Materials and other inventory are scheduled to arrive based on when they are needed in the production process.

Just-in-time (JIT)

Similar to MRP. More integration between production and supplier.

Explain matching (principles of financing)

Borrowers should try to match the lives of financial instruments with those of the assets that they want to fund.

Sources of short-term financing

Overdraft


Factoring - three services


1. Provision of finance


2. Sales ledger administration


3. Credit insurance

Permanent current asset versus


Seasonal temporary current asset

Permanent current asset - asset required at seasonal low level




Seasonal temporary current assets - difference between assets required at the season highest level and permanent level.




Changes occurs at A/R, inventory, and cash

Spontaneous permanent liabilities versus spontaneous seasonal liabilities

Spontaneous permanent liabilities - current liabilities required at the seasonal low level




Spontaneous seasonal liabilities - difference between liabilities required at the season highest level and spontaneous perm liabilities.



Extremely conservative approach

Ensures that all long-term assets are financed through long-term liabilities, as well as seasonal and permanent portions of net working capital.




Company will not have any current liabilities other than spontaneous accounts payable, accrued taxes, and accrued liabilities. (scroll)




high level of working capital




trading off higher borrowing costs for a low liquidity risk.

Aggressive approach

Relying on long-term debt to finance only a portion of the long-term assets and the permanent net working capital.




Save interest charge but will increase the liquidity risk``

Moderately conservative approach

Financing some of the seasonal needs for net working capital with long-term liability and the balance with short-term financing.




Liquidity buffer

Liquidity buffer

Portion of NWC financed with long-term debt.




Size of the buffer will depending on a company's ability to generate cash from operations.