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FM (Test) > C Section C Theory > Flashcards

C Section C Theory Flashcards

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1
Q

Techniques to managing trade receivables (creditworthiness)

A

By assessing the creditworthiness of new customers. In order to do this, the company needs to review information from a range of sources. These sources include trade, bank and credit references

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2
Q

Techniques to managing trade receivables (terms)

A

Make sure that its credit customers abide by the terms of trade agreed when credit was granted following credit assessment. Aged receivables analysis can provide info on overdue accounts

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3
Q

Techniques to managing trade receivables (collecting amounts owing)

A

Credit customers will pay on time and no need to chase late payers. Credit control staff must assess whether payment is likely wen payment is overdue

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3
Q

Techniques to managing trade receivables (settlement discounts)

A

Encourage its credit customers to settle outstanding amounts by offering an early settlement discount. This will offer a reduction in the outstanding amount (the discount) in exchange for settlement before the due date

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4
Q

Example of an early settlement discount?

A

If the credit customer agreed to pay in full after 40 days, an early settlement discount might offer a 2% discount for settling after 25 days

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5
Q

Techniques to managing trade receivables (credit control)

A

Credit control staff must assess whether payment is likely to be forthcoming and if not, a clear policy must be in place on further steps to take (e.g. legal action)

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6
Q

Techniques to managing trade receivables (invoice discounting)

A

A service whereby a third party, usually a factor, pays a percentage of the face value of a collection of high value invoices

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7
Q

What is a working capital investment policy?

A

Considers the level of current assets used to support revenue generation in relation to different companies

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8
Q

When does a company adopt an aggressive working capital investment policy

A

If a company uses a lower level of current assets to support a similar level of revenue generation compared to another company

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9
Q

How can changes in working capital policy be measured?

A

By the revenue/current assets ratio

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10
Q

What does a conservative funding policy use?

A

Long-term funds to finance permanent current assets and a proportion of fluctuating current assets

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11
Q

What does an aggressive funding policy use?

A

Short-term funds to finance fluctuating current assets and a proportion of permanent current assets

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12
Q

Benefit of using short-term funds in a funding policy?

A

The policy increases profitability but is riskier

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13
Q

What is a matching funding policy?

A

Apply the matching principle in using short-term funds to finance fluctuating current assets and using long-term funds to finance permanent current assets

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14
Q

What do permanent current assets represent? (working capital funding strategies)

A

Core level of current assets needed to support normal levels of business activity

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15
Q

What is meant by fluctuating current assets? (working capital funding strategies)

A

Business activity will be subject to unexpected variations

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16
Q

Matching principle (working capital funding strategies)

A

Maturity of assets should be reflected in the maturity of the finance used to support them

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17
Q

Matching principle and short-term finance (working capital funding strategies)

A

Fluctuating current assets

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18
Q

Matching principle and long-term finance (working capital funding strategies)

A

Permanent current assets and non-current assets

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19
Q

Conservative funding policy and current and non-current assets? (working capital funding strategies)

A

A conservative funding policy would use long-term finance for permanent current assets, non-current assets and some of the fluctuating current assets, with short-term finance being used for the remaining fluctuating current assets

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20
Q

Aggressive funding policy and current and non-current assets? (working capital funding strategies)

A

An aggressive funding policy would use long-term finance for the non-current assets and part of the permanent current assets, and short-term finance for fluctuating current assets and the balance of the permanent current assets

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21
Q

managerial risk (working capital funding strategies)

A

Managerial attitudes to risk can lead to a company preferring one working capital funding policy over another (e.g. a risk-averse managerial team might prefer a conservative working capital funding policy)

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22
Q

When short-term finance is preferred in working capital funding?

A

When short-term finance is preferred

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23
Q

What happens when revenue/business activity increases for working capital funding?

A

Level of permanent current assets will also increase

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24
What is working capital only concerned for in the financing choice?
The distinction between short-term and long-term financing
25
What is the transactions need for cash?
The amount of cash needed for the next period can be forecast using a cash budget
26
What is the precautionary need for cash?
Although a cash budget will provide an estimate of the transactions need for cash, it will be based on assumptions about the future and will, therefore, be subject to uncertainty. The actual need for cash may be greater than the forecast need for cash
27
What is the speculative need for cash?
There is always the possibility of an unexpected opportunity occurring in the business world and a company may wish to be prepared to take advantage of such a business opportunity if it arises
28
Why is cash useful when searching for availability of finance?
A company may choose to hold higher levels of cash if it has difficulty gaining access to cash when it needs it
29
What is overtrading?
Overtrading arises when a company does not have enough long-term finance to support its level of trading activity
30
Effect on receivables collection period when overtrading?
Increases alongside an increase in revenue
31
Effect on profitability when overtrading?
A decrease alongside an increase in revenue
32
Effect on current assets when overtrading?
Increase is far greater than the increase in long-term finance, an increase in revenue
33
Funding strategy when overtrading?
Increased its dependence on short-term finance
34
Effect on liquidity when overtrading?
A decrease when compared to other companies
35
What must be done with overdue accounts?
Overdue accounts must be followed up in order to assess the likelihood of payment and to determine what further action is needed
36
Why a company may benefit from services of a factoring company (specialisation)
Experts at getting customers to pay promptly and may be able to achieve payment periods and bad debt levels which clients could not achieve themselves
37
Why a company may benefit from services of a factoring company (value of invoices)
Factor will advance up to 80% of the value of invoices raised, allowing a company quicker access to cash from sales
38
Why a company may benefit from services of a factoring company (free up management time)
Factoring can free up management time and allow them to focus on more important tasks
39
Why a company may benefit from services of a factoring company (administration costs)
Since administration of trade receivables would be taken over by the factor, administration costs of the company would decrease over time
40
Factors that determine level of a company's investment in working capital (nature of industry)
Some businesses have long production processes which inevitably lead to long working capital cycles and large investments in working capital (e.g. housebuilding requires large investment in capital)
41
Factors that determine level of a company's investment in working capital (working capital investment policy)
Some companies take a conservative approach to working capital investment, offering long periods of credit to customers (to promote sales), high levels of inventory (to prevent stockouts) and prompt payments to suppliers (to maintain good relationships)
42
Factors that determine level of a company's investment in working capital (terms of trade)
If management of the components of working capital is neglected, investment in working capital can increase (e.g. bad credit control results in high level of AR)
43
Ways to assess credit risk (references)
References are useful in this respect, and potential customers should supply a bank reference and a trade or other reference when seeking credit on purchases
44
Ways to assess credit risk (credit rating)
Credit rating of the potential customer, which can be checked by a credit rating agency or credit reference agency
45
Objectives of working capital management
Ensure profitability whilst ensuring liquidity. About getting the right balance between current assets and current liabilities
46
Problem with high level of current assets?
They are not profitable
47
Problem with high levels of non-current assets?
Could generate higher returns for the company but would impact its ability to settle its liabilities
48
Benefit of accepting the discount and buying in larger quantities?
Cost is reduced, increasing profitability. But there is less cash in bank due to high inventory, meaning liquidity affected
49
What is the cash operating cycle walkthrough?
Having paid for the inventory, the cash operating cycle is the length of time it remains in inventory before being sold and then how long until the customer pays for it and cash is returned to the bank account
50
Effect of paying suppliers quickly on the cash operating cycle?
Increase the investment in working capital due to low levels of trade payables, but will again increase the cash cycle
51
What is a working capital investment policy?
Dictates how much a company chooses to invest in current assets
52
What is a working capital financing policy?
Determines how a company funds its day to day operations: with short-term or long-term sources
53
Characteristics of a conservative working capital investment policy
Holds high levels of working capital, generous credit terms, high levels of inventory and quick payment of suppliers. High financing cost
54
Characteristics of a aggressive working capital investment policy?
Cutting inventories, collecting debts early and delaying payments to suppliers. Reduces financing cost
55
Characteristics of a conservative working financing policy
Uses long-term funding to finance most of the assets of the company. Only uses short-term when fluctuations in current assets push total assets above a certain level
56
Characteristics of an aggressive working financing policy
Finances all fluctuating current assets and some permanent current assets out of short-term sources. Greater liquidity issues but lower financing costs
57
What determines the length of the working capital cycle?
Industry a company operates in Efficiency of a company's working capital management
58
When AR takes longer to be settled?
More money the company will have invested
59
What is cash management often regarded as?
An idle asset as it earns no return
60
What is meant by a negative working capital cycle?
Company was paid by customers before it started to spend cash on production
61
An example of a negative working capital cycle? (supermarkets)
Supermarkets often receive payments for goods before they have paid for them
62
What is meant by liquidity in a cash flow surplus?
How quickly and easily an asset can be converted into cash
63
What is meant by profitability in a cash flow surplus?
Company should seek to obtain a good return for the risk incurred
64
What is meant by safety in a cash flow surplus?
Risk of the asset reducing in value
65
What are fixed costs in obtaining cash in the Baumol model?
Issue cost of equity finance or the cost of negotiating an overdraft
66
What are variable costs in obtaining cash in the Baumol model?
Opportunity cost of keeping the money in the form of cash
67
Drawbacks of Baumol model (buffer)
No buffer inventory of cash is allowed for
68
Drawbacks of Baumol model (predict)
Unlikely to be possible to predict amounts required over future periods with much uncertainty
69
Drawbacks of Baumol model (constant)
Assumes constant transaction costs and interest rates
70
What does the Miller-Orr model take into account?
Uncertainty in relation to cash flows
71
When cash balance reaches an upper limit?
The firm buys sufficient securities to return the cash balance to a normal level
72
When cash balance reaches a lower limit?
Firm sells securities to bring the balance back to the return point
73
Risks arising from granting credit to foreign customers (discounting bills of exchange)
A bank buys the bill before it is due and credits the value of the bill after a discount charge to the company's account
74
Risks arising from granting credit to foreign customers (export factoring)
Where the exporter pays for the specialist expertise of the factor
75
Risks arising from granting credit to foreign customers (countertrade)
Means of financing trade in which goods are exchanged for other goods
76
Risks arising from granting credit to foreign customers (documentary credits)
A method of payment in international trade, which gives the exporter a secure risk-free method of obtaining payment

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