Week 12 Flashcards
What occurs in the operating and cash cycle of a business? Which is longer?
The operating cycle for a business starts by buying inventory, then it pays for the inventory, then the firm sells the product, and then the firm receives payment. In between buying and paying for inventory it is accounts payable, in between selling the product and receiving payment it is accounts receivable.
The cash cycle starts at paying for inventory, in which there is a cash outflow, then when the firm receives payment there is a cash inflow.
The operating cycle is therefore longer than the cash cycle.
What is the equation for the cash conversion cycle? What does it mean if this is negative?
The Cash conversion cycle (CCC) = inventory days + accounts receivable days – accounts payable days.
Where the inventory days is the inventory divided by average daily cost of goods sold.
Where the Accounts receivable days = (accounts receivable/average daily sales)
Where the accounts payable days = (accounts payable/average daily cost of goods sold).
A negative cash conversion cycle means the firm receives cash in before they pay for the input.
What is the discount rate used for free cash flow?
The discount rate used for free cash flow will be the cost of capital or the cost of equity, depending on whether interest has already been removed.
What does a change in working capital do to our free cash flow?
An increase in working capital will decrease our free cash flow, a decrease in working capital will increase free cash flow.
What is trade credit? What are the main periods within it? What is the cost of trade credit?
An increase in working capital will decrease our free cash flow, a decrease in working capital will increase free cash flow.
What are the benefits of trade credit for customer firms?
Trade credit benefits for customer firms: It is simple and convenient, and has lower transaction costs than alternative sources of funds, it is a flexible source of funds and can be used as needed, it is sometimes the only source of funding available for a firm.
What are the benefits of trade credit for supplier firms?
Trade credit benefits for supplier firms: It provides financing at below-market rates as an indirect way to lower prices for certain customers, a supplier may have ongoing business with its customer, it may have more information about the credit quality of the customer than a traditional outside lender would have, if the buyer defaults, the supplier may be able to seize the inventory as collateral.
What are the three steps to determining credit policy and the 5C’s of credit?
Determining credit policy has three steps: establishing credit standards, establishing credit terms, and establishing a collection policy.
The 5 C’s of credit are: Character, capacity, capital, collateral, and conditions.
What are some important things to monitor when managing accounts receivable?
It is important to monitor accounts receivable when doing receivables management, this will involve:
The accounts receivable days, the average number of days it takes a firm to collect on its sales,
the aging schedule, which categorizes accounts by the number of days they have been on the firm’s books, it is prepared using either the number of accounts or the dollar amount of the accounts receivable outstanding,
And the payments patterns, information on the percentage of monthly sales that the firm collects in each month after the sale.
What are some useful things to keep in mind with payables management?
For payables management we should determine accounts payable days outstanding, this is important to ensure that payments are made at an optimal time. They could also consider stretching the accounts payable, this means ignoring a payment due period and paying later.
What are the benefits of holding inventory? What about the costs?
The benefits of holding inventory are: Inventory helps minimize the risk that the firm will not be able to obtain an input it needs for production and helps avoid stock-outs. Factors such as seasonality in demand mean that customer purchases do not perfectly match the most efficient production cycle.
The costs of holding inventory are: Acquisition costs, order costs, and carrying costs.
What is Just-In-Time inventory management?
Just-In-Time inventory management is a perfect state of inventory management, in which a firm acquires inventory precisely when needed so that its inventory balance is always zero, or very close to it.
What are the motivations for holding cash? What can a firm do if it has too much?
The motivations for holding cash are:
-transactions balance, meeting day to day needs.
-Precautionary balance, to compensate for the uncertainty associated with its cash flows.
-Compensating balance, to satisfy bank requirements.
If a firm has excess cash there are several short-term securities that firms with excess cash can invest in.
Why is it important to forecast short-term financing needs?
Forecasting short-term financing needs is important to allow us to see any problems with cash surplus or deficit, and whether this is temporary or permanent.
What is the matching principle in terms of financing?
The matching principle states that short-term needs should be financed with short-term debt and long-term needs should be financed with long-term sources of funds.
