B2 - M5: Working Capital Management II Flashcards
Motives for hoarding cash
1) Transaction motive - cover expenses in ordinary course of business
2) Speculative motive - take advantage of temporary opportunities
3) Precautionary motive - “emergency fund”
Affect of hoarding too much cash
- could cause company to miss out on investment opportunities by not being invested
- might look bad to investors for sitting on cash and using it to acquire more assets to grow
Methods to increase cash
1) increasing inflow
2) Decreasing outflow
3) faster collection of AR
4) delay AP payments
How do AR Turnover and Days Sales in AR ratios help management?
- helps them evaluate their credit policy
- too generous could decrease cash inflow
- too strict could displease customers and even turn away potential cusotmers
Effective Interest Rate
- cost of financing
= Amount paid on loan / Net proceeds
ALSO
= loan amount x interest rate / (100% - Compensating Balance) x loan amount
How can a company increase collections?
- adjust customer screening and credit policies
- prompt billing
- early payment discounts
- expedite deposits by using EFTs or Lockbox system
- Concentration banking
What is AR Factoring
exchanging AR with a 3rd party in exchange for a ST loan
How to compute cost of financing using AR Factoring?
1) AR submitted x Factoring fee x (Days per year/ Days in period) = Subtotal 1
2) AR submitted - % withheld by Factorer = Amount subject to Interest
3) Amount subject to interest x Factoring Fee x (Days per year/ Days in period) = Subtotal 2
4) Subtotal 1 + Subtotal 2 = Cost to Company
5) Cost to Company - Expense Saved due to Outsourcing = Net Cost
6) APR Cost of Financing by Factoring = Net Cost / Amount Subject to Interest
Letter of Credit
- 3rd party (typically a bank) guarantees that a seller will receive a buyer’s payment on time and in full
- often used with international customers. The bank will guarantee payment if customer doesn’t
Line of Credit
Revolving bank loan allows a company access to funds as needed, up to a certain amount
What factors are used to determine if a company is eligible for a line of credit and the amount?
Financial strength and stability
When should a company offer credit terms?
When competitors are or when they need to improve CF
Float
- difference between checks outstanding and deposits in transit
- 10k check x 5 days = 50k - outstanding (disbursed but not deposited)
10k check x 4 days = 40k - in transit (received but not cleared by bank)
= 50k - 40k = 10k float
Cost to Carry Additional Investment in AR
1) Determine average of existing and additional AR
* Avg AR = Annual Sales / (360/Avg Collection Period) - compute this under old policy and again w/ new policy
* Additional AR = New Credit Policy Avg AR - Old Credit Policy Avg AR
2) Determine additional investment in AR
* Additional Investment in AR = Additional AR x Cost Ratio
3) Calculate additional carrying cost
* Additional Carry Cost = Additional Investment in AR x Required rate of return
ST vs LT Financing
- LT financing decreases interest rate risk and increases capital availability
ST
- typically lower rates = lower financing costs
- affects working capital so current assets must be sufficient to meet ST liabilities
- allows for rapid acquisition of inventory which can increase profitability
- susceptible to interest rate fluctuations (interest rate risk)
- decreased capital availability if creditworthiness changes (evaluation happens more often)
LT
- typically higher rates = higher financing costs
- less susceptible to interest rate fluctuations (interest rate risk)
- increases capital availability
