C Theory Flashcards
(170 cards)
1
Q
WHat is wroking capital?
A
The capital represented by net current assets which is available for day-to-day operating activities
2
Q
Result of not having sufficient working capital? (overdraft)
A
Exceeding an agreed overdraft limit
3
Q
Result of not having sufficient working capital? (suppliers)
A
Failing to pay suppliers (including employees) on time
4
Q
Result of not having sufficient working capital? (discount)
A
Inability to take advantage of discounts for prompt payment
5
Q
Issue if a business ties up too much resource in working capital?
A
Earn a lower-than-expected rate of return on capital employed
6
Q
Why is working capital management crucial for effective management of a business (current)
A
Current assets may be a high proportion of total assets
7
Q
Why is working capital management crucial for effective management of a business (working)
A
Failure to control working capital, and therefore liquidity, is a major cause of business failure
8
Q
When there’s high investment in working capital?
A
More liquid but less profitable due to insufficeint use of working capital
9
Q
When there’s low investment in working capital?
A
Less liquidity but more profitable as business may be using working capital efficiently
10
Q
What is overtrading?
A
When there is insufficient working capital to support the level of business activity.
11
Q
What is over-capitalisation?
A
An excessive level of working capital, leading to inefficiency
12
Q
When management is highly risk-averse?
A
It will take a conservative approach to the level of investment in current assets
13
Q
Problems with conservative approach to current asset investment policy?
A
Inventory obsolescence
High financing costs for the high level of assets
14
Q
When management takes an aggressive approach?
A
Drive down the levels of inventory, receivables and holdings of surplus cash. More risky but can be more profitable due to low investment in current assets
15
Q
Why is low working capital risky (inventory)
A
Running out of inventory in periods of fluctuating demand
16
Q
Why is low working capital risky (credit)
A
Losing customers to competitors who offer more generous credit
17
Q
Problems with accounts payable for short-term funding (excessive credit)
A
Taking excessive credit may lead to lost goodwill with suppliers and even penalties for late payment.
18
Q
Problems with accounts payable for short-term funding (settlement)
A
Appears cheap, but refusing settlement discounts can be expensive
19
Q
Problems with bank for short-term funding (renegotiation)
A
Renegotiation risk (i.e. the bank may refuse to refinance on maturity).
20
Q
Benefit with bank for short-term funding (interest)
A
Usually lower interest rate than long-term debt
21
Q
Benefit with overdraft for short-term funding (repayable)
A
Repayable on demand
22
Q
Problem with overdraft for short-term funding (variable)
A
Variable interest rate exposes entity to rate rises
23
Q
Benefit of equity for long-term funding (legal)
A
No legal commitment to repay
24
Q
Benefit of debt for long-term funding (interest)
A
If interest rates are fixed, is not affected by rising rates (until maturity)
25
Reason why some current assets on the SFP may be more permanent?
Holding a minimum "precautionary" balance of cash to meet any unexpected payments
26
Aggressive financing policy perspective of funding current assets?
Use short-term finance not only for the fluctuating balance of current assets but also for some, if not all, of the permanent balance
27
COnservative financing policy perspective of funding current assets?
Long-term finance not only for the permanent level of current assets but also for part, if not all, of the fluctuating balance
28
Issue if current ratio falls below 1?
May indicate problems in meeting obligations as they fall due
29
Issue with a very high current ratio?
Indicate inefficient use of resources (e.g. excessive cash balances)
30
When is quick ratio relevant?
when inventory is slow moving and cannot be converted into cash quickly
31
Minimum requiremetn for quick ratio?
Have a quick ratio of at least one
32
What does the inventory turnover show?
How quickly inventory is sold, with higher turnover reflecting faster-moving inventory
33
What does the inventory holding period show?
The time taken for inventory to be sold. Everything else being equal, management would prefer a shorter period
34
What does the receivables collection period show?
The time taken for a customer to pay. Everything else being equal, management would prefer a shorter period
35
What does the payables payment period show?
The time taken to pay suppliers. Management would prefer to increase the credit period unless this proves expensive in terms of lost discounts or leads to other problems such as reduced reliability or quality of supplies
36
What does sales/working capital indicate?
How efficiently a business uses its working capital to generate sales. Everything else being equal, management would prefer sales/working capital to rise.
37
When calculating and interpreting ratios (past)
Ratios concern the past and do not predict the future
38
When calculating and interpreting ratios (seasonal)
Seasonal and other factors may mean that the amounts in the statement of financial position are atypical
39
What is the working capital cycle?
Is the period (in days, weeks or months) between paying suppliers and receiving cash from customers
40
What do businesses want with the working capital cycle?
A business will want to minimise the length of its working capital cycle, thereby reducing its exposure to liquidity problems
41
When the working capital cycle is longer?
The greater the resources invested in working capital
42
Factors that affect cycle length (power of suppliers)
An attempt to delay payments could lead to a supplier demanding “cash on delivery”
43
Factors that affect cycle length (terms of trade)
Credit period offered to customers
44
Factors that affect cycle length (industry norms)
If competitors offer long credit periods, reducing the receivables collection period may be challenging without losing business
45
Cost of holding inventory?
storage;
security; and
losses due to theft, obsolescence and goods perishing
46
Why are receivables important?
Sales exist on paper, the associated cash receipts take too long to materialise, and cash flow problems occur
47
Problem if a business consistently exceeds the credit period imposed by suppliers?
Its credit rating will be damaged in the long term
48
What must a business do to address liquidity problems?
Businesses must plan to ensure that sufficient cash is available to meet expenses in the off-peak period
49
Indicators of overtrading (liquidity)
Declining liquidity
50
Indicators of overtrading (overdraft)
Rising overdraft and increase in short-term borrowing
51
Indicators of overtrading (inventory and receivables)
Increasing inventory and receivables ratios
52
Reduce working capital cycle (cash)
Reducing the credit period extended to accounts receivable and tightening up on cash collection
53
Reduce working capital cycle (suppliers)
Increasing the period of credit taken from suppliers
54
Reduce working capital cycle (production)
Reducing the production period
55
How are settlement discounts influenced?
By accepted practice within the industry
56
What is an aged receivables list?
Detailing the length of time outstanding amounts have been owed
57
What is a credit utilisation report?
Showing the proportion of each customer’s credit limit that is currently utilised
58
Use to assess creditworthiness (bank reference)
A bank reference, which is relatively easy to obtain
59
Use to assess creditworthiness (credit rating)
Credit rating/reference agencies are professional businesses which sell information about companies and individuals
60
Use to assess creditworthiness (financial)
Information from financial media, including national and local press, suitable trade journals and the Internet
61
Methods to help customers pay on a timely basis (monthly statements)
Produced quickly and easily by any computerised sales ledger system and sent to customers
62
Methods to help customers pay on a timely basis (chasing letters)
Directed to a specific person, preferably at a reasonably senior level
63
Methods to help customers pay on a timely basis (stopping supplies)
Customer depends on the organisation’s goods or services
64
What is a bill of exchange?
A document drawn by the exporter and sent to the customer, who signs to accept responsibility to pay the amount specified on the stated date
65
What is forfaiting?
Bank discounting a series of bills of exchange without recourse to the exporter if the customer does not pay
66
What are documentary letters of credit?
A payment guarantee backed by one or more banks
67
Letters of credit advantage (assurance)
Letters of credit provide a high level of payment assurance for the seller. Once Ts & Cs are met, the seller is guaranteed to receive payment
68
Letters of credit advantage (periods)
Sellers can negotiate favourable payments such as shorter payment periods to improve cash flow
69
Letters of credit disadvantage (set up)
Set up can be complex and take a significant amount of time before the sale occurs
70
Letters of credit disadvantage (terms)
Minor discrepancies in rigid Ts & Cs can lead to delays or even non-payment
71
What is open account trading?
Trusting the customer to pay within the stated credit period without additional collateral or security
72
What is cash against documents?
Documents of title to the goods are not released to the customer until payment is made
73
What is export credit houses?
Organisations that give credit to the overseas customer and guarantee payment to the exporter
74
What is export merchant?
Organisations that operate as intermediaries between the exporter and the overseas customer
75
What is export credit insurance?
Protects against risks that could result in non-payment by a foreign customer
76
What is export factoring?
Factors buy the trade receivables from the exporter and charge a commission on the transaction
77
What is invoice discounting?
The selling of selected sales invoices to a third party for a discounted cash sum, while retaining full control over the receivables ledger
78
Advantage of discounting (improved cash flow)
The business receives a significant proportion of invoice amounts upfront
79
Advantage of discounting (flexibility)
Business can choose which invoices to discount, accessing funds when needed
80
Disadvantage of discounting (fees)
Fees and interest charges make it an expensive form of financing compared to an overdraft or bank loan
81
Disadvantage of discounting (receivable)
As the finance company has a legal charge over the receivable balances, the business has fewer assets to secure other borrowings
82
What are debt factors?
Businesses offering a range of services in the area of sales administration and the collection of amounts due from customers
83
Debt factors (accounting and collection)
The company is paid by the factor as customers settle their invoices or after an agreed settlement period. The factor will maintain the sales ledger accounting function
84
Debt factors (credit control)
The factor is responsible for chasing the customers and speeding up the collection of debts
85
Advantage of factoring (improved cash flow)
Conversion of receivables into immediate cash
86
Advantage of factoring (administrative)
Outsourced debt collection saves time and effort
87
Disadvantage of factoring (cost)
Factoring fees can be relatively high
88
Disadvantage of factoring (selective factoring)
The business cannot factor all receivables, managing accounts will be fragmented
89
What is factoring with recourse?
Bad debts remain the company's problem
90
What is non-recourse factoring?
Bad debts are the factor's problem. In effect, the company is insured against bad debts. Fees are higher for non-recourse factoring
91
Issue with early settlement discounts?
Make it more difficult to manage the sales ledger
92
Advantages of trade credit (institutions)
Can be used if unable to obtain credit from financial institutions
93
Advantages of trade credit (cash flow)
Can be used short-term to overcome unexpected cash flow crises
94
Inventory control?
The systematic regulation of inventory levels
95
Inventory control is important because (high)
Too high inventory levels incur additional costs and profits will be reduced
96
Inventory control is important because (low)
Too low inventory levels are insufficient to satisfy customers and profit will be reduced
97
Reasons for holding inventory (buffer)
To meet demand by acting as a buffer when consumption is unusually high
98
Reasons for holding inventory (ordering)
To reduce ordering costs
99
Reasons for holding inventory (quantity)
To take advantage of quantity discounts
100
Examples of holding costs?
Insurance;
Deterioration, obsolescence and theft;
Warehousing
101
Examples of re-order costs?
Transport costs;
Clerical and administrative expenses
102
Examples of shortage costs?
Stock-out costs for finished goods
Production stoppages caused by lack of raw materials
103
What is economic order quantity (EOQ)
The optimal order quantity that minimises the total costs relevant to ordering and holding inventory
104
Assumption of EOQ (demand)
Constant demand
105
Assumption of EOQ (order)
Order costs are independent of order quantity
106
Assumption of EOQ (stock)
No risk of stock-outs
107
Assumption of EOQ (level)
Assumption that holding costs vary with the average inventory level
108
What is re-order level?
The level to which inventory should fall before placing a purchase order for replenishment
109
What is lead time?
Time between placing and receiving an order
110
What does JIT purchasing system aim to minimise?
Minimise the cost of holding inventory by placing orders so that delivery is timed for when the goods are needed
111
What does JIT production system aim to minimise?
The cost of manufacturing by only producing goods as they are needed
112
How to operate a JIT inventory sustem (suppliers)
Sufficiently flexible suppliers and internal workforce to expand and contract output at short notice
113
How to operate a JIT inventory sustem (factory)
The factory design and layout must facilitate JIT deliveries to all areas
114
How to operate a JIT inventory sustem (investment)
Significant investment by suppliers, who will require long-term agreements
115
How to operate a JIT inventory sustem (material)
The quality of raw material inventory must be guaranteed
116
Treasury management?
The efficient management of liquidity and risk in a business including the management of funds
117
Centralised treasury management advantages (staff)
Management by specialised staff with appropriate qualifications, expertise
118
Centralised treasury management advantages (negotiating)
Increased negotiating power with banks, as the amounts borrowed or deposited would be more substantial as a group
119
Centralised treasury management advantages (economies)
Economies of scale (e.g. less staff required), as specialists are employed centrally, reducing duplication
120
What is the treasurer involved in (borrowing)
Planning short-term borrowing when necessary
121
What is the treasurer involved in (cash flow)
Accurate cash flow forecasting, so that shortfalls and surpluses can be anticipated
122
What is the treasurer involved in (transmission)
Cost-efficient cash transmission
123
Why hold cash (transactions)
Cash is held to provide sufficient liquidity to meet current day-to-day financial obligations
124
Why hold cash (precautionary)
A cash reserve is held as a “cushion” against unplanned expenditure
125
Why hold cash (speculative)
Cash is held to take advantage of potential investment opportunities quickly
126
How may surplus funds arise (overfunding)
Proceeds which are not yet fully required may have already been received from a share/debt issue
127
How may surplus funds arise (disposal)
Disposal of surplus assets or divisions
128
How should long-term surpluses be invested?
Into positive NPV projects or used to pay a dividend
129
How should short-term surpluses be invested?
To invest in short-term, low-risk, highly liquid investments
130
Factors in investing surplus funds
Amount of funds, required level of liquidity and risk tolerance
131
Most businesses achieve the following objectives?
Minimise the risks involved, obtain higher returns
132
When should money market deposits only be used?
Investments may have a notice period for withdrawals; therefore, they should only be used if there is a high certainty of cash flows
133
What are certificates of deposits?
Negotiable deposits issued by banks, with maturities from 28 days to five years
134
What are treasury bills?
Two, three, and six-month UK government debt
135
What are gilt-edged government securities?
Long-term version of Treasury bills with maturities usually over five years
136
Certificates of tax deposit?
Deposits with UK HM Revenue and Customs that earn interest
137
Commercial paper?
Short-term (seven days to three months) unsecured debt issued by high-quality companies, good liquidity
138
Corporate loan notes?
Longer maturity, fixed interest securities issued by the corporate sector
139
Equities?
Investing short-term cash surpluses in the stock market is not recommended because of the high risk associated with equity investments
140
What does Baumol model suggest?
Regular transfers from interest-bearing, short-term investments (or bank deposit accounts) into a current account
141
What does the baumol model consider (demand)
The annual demand for cash
142
What does the baumol model consider (transfer)
Cost of each transfer from short-term investments into cash
143
Baumol model assumptions (cash)
Cash needs are steady and predictable and funded by the sale of short-term investments
144
Baumol model assumptions (demand)
Constant annual demand for cash
145
Baumol model assumptions (interest)
Constant interest rates
146
Baumol model weaknesses (cash)
The assumption of constant demand for cash is unrealistic
147
Baumol model weaknesses (financed)
The model assumes a constant use of cash financed by selling investments. However, any worthwhile business mus generate cash rather than "burn" it.
148
Why is Miller-Orr better than Baumol?
As the assumption of constant demand for cash in the Baumol model is unrealistic
149
What does the Miller-Orr model allow?
Uncertainty in cash receipts and payments
150
What if lower limit is reached in Miller-Orr
An amount of cash equal to the difference between a default "return point" and the lower limit is raised by selling short-term investments
151
What if upper limit is reached in Miller-Orr
Amount of cash equal to the difference between the upper limit and the return point is used to buy short-term investments
152
What does Miller-Orr want to do?
Decrease the risk of running out of cash, while avoiding the loss of profit caused by unnecessarily high cash balances
153
Assumptions of Miller-Orr (minimum)
A minimum acceptable cash balance, the lower limit
154
Assumptions of Miller-Orr (random)
Changes in daily cash balance are random (normally distributed)
155
Assumptions of Miller-Orr (fixed)
A fixed transaction cost per sale/purchase of short-term investments
156
Weaknesses of Miller-Orr (subjectivity)
Subjectivity in setting a lower limit
157
Weaknesses of Miller-Orr (volatility)
The complexity of estimating future volatility of cash flows
158
When should diluted EPS be calculated
Where a company has a complex capital structure that includes potentially dilutive securities
159
What are PDSs
Securities in issue that have an obligation to issue shares in the future (e.g. convertible debt or share options)
160
What does dividend coverage ratio provide?
An estimate for investors of the risk of not receiving dividends
161
What does dividend payout ratio provide?
How much money a company returns to its shareholders compared to how much it keeps to reinvest in growth, pay off debt and add to cash reserves
162
What does dividend yield provide?
An investor the percentage of the share price paid out in dividends each year
163
What is earnings yield used for?
Assess the rate of return on their investment
164
What is financial gearing?
Degree to which a company’s activities are funded by debt compared to equity
165
What is operational gearing?
Describes the effect of fixed costs on the relationship between sales revenue and operating profits
166
What happens when operational gearing increases?
Profits become more volatile compared to changes in sales
167
What can interest coverage be used for?
Measures a company's ability to pay interest on its debt. To determine both short-term financial health and company stability
168
What does ROE measure?
an organisation’s overall performance and shows the earning power of the shareholders’ book investment
169
A higher ROE could indicate (control)
Good cost control or investment in profitable projects
170
A higher ROE could indicate (geared)
Company is more geared and has more risk associated with shareholder returns
