chapter 26

Question 1

net working capital components

Answer 1

cash, inventory, receivables, and payables. it does not include excess cash.

Question 2

excess cash

Answer 2

cash that is not required to run the business and can be invested at the market rate.

Question 3

cash cycle

Answer 3

the length of time between when the firm pays cash to purchase its initial inventory and when it receives cash from the sale of the output produced from that inventory.

Question 4

operating cycle

Answer 4

the average length of time between when a firm originally purchases its inventory and when it receives the cash back from selling its product. if the firm pays cash for its inventory, this is identical to the cash cycle.

Question 5

working capital level

Answer 5

reflects the length of time between when cash goes out of a firm at the beginning of the production process and when it comes back in.

Question 6

trade credit

Answer 6

the credit the firm extends to its customers when a firm allows a customer to pay for goods at some date later than the date of purchase, creating an account receivable for the firm and an account payable for the customer. it is in essence a loan with the price discount as interest rate.

Question 7

terms of trade credit

Answer 7

eg. 2/10, Net 30. meaning 2% discount if paid within 10 days and full amount due at 30 days.

Question 8

cost of the discount

Answer 8

for the selling firm equals the discount percentage times the selling price.

Question 9

processing float

Answer 9

how long it takes the firm to process the check and deposit it in the bank.

Question 10

collection float

Answer 10

the amount of time it takes for a firm to be able to use funds after a customers has paid for its goods.

Question 11

mail float

Answer 11

how long it takes the firm to receive the check after the customer has mailed it.

Question 12

availability float

Answer 12

how long it takes before the bank gives the firm credit for the funds.

Question 13

disbursement float

Answer 13

the amount of time it takes before payments to suppliers result in a cash outflow for the firm. it is a function of mail time, processing time, and checking and clearing time.

Question 14

accounts receivable days

Answer 14

a tool to monitor accounts receivable after establishing a credit policy to see if it is working effectively. a firm can compare this number to the payment policy specified in credit terms and look at the trend over time.

Question 15

aging schedule

Answer 15

categorises accounts by the number of days they have been on the firm’s books. it can be prepared using the number of accounts or dollar amount of accounts receivable outstanding.

Question 16

‘bottom-heavy’ aging schedule

Answer 16

an aging schedule where the percentages in the lower half of the schedule begin to increase. in this case the firm needs to revisit its credit policy.

Question 17

payment pattern

Answer 17

provides information on the percentage of monthly sales that the firm collects in each month after the sale. an analysis of payment pattern can augment the aging schedule.

Question 18

stretching accounts payable

Answer 18

a practice where the firm ignores the payment due period and pays later. doing this reduces the direct cost of trade credit because it lengthens the time that a firm has use of the funds.

Question 19

stock-out

Answer 19

the situation when a firm runs out of goods and loses sales because too little inventory is held.

Question 20

acquisition costs

Answer 20

the costs of the inventory itself over the period being analysed (usually one year).

Question 22

carrying costs

Answer 22

include storage cost, insurance, taxes, spoilage, obsolescene, and the opportunity cost of the funds tied up in inventory.

Question 23

‘just-in-time’ (JIT) inventory management

Answer 23

when a firm acquires an inventory precisely when needed so that the inventory balance is always zero, or very close to it. it requires exceptional coordination with suppliers and a predictable demand. firms seek to reduce their carrying costs as much as possible.

Question 24

transactions balance

Answer 24

the amount of cash a firm needs to be able to pay its bills.

Question 25

precautionary balance

Answer 25

the amount of cash a firm holds to counter the uncertainty surrounding its future cash needs.

Question 26

compensating balance

Answer 26

an account at the bank as compensation for services that the bank performs. they are usually deposited in accounts with no or very low interest.

Question 27

money market securities

Answer 27

short-term debt securities a firm may invest in directly or through money market mutual funds. they are liquid with low default risk.

Question 28

quick ratio

Answer 28

a common measure used to assess whether the firm has adequate liquidity to meet short-term needs. it is the ratio of current assets other than inventory to current liabilities.

Question 29

treasury bills

Answer 29

short-term debt of the US government. it is default risk free, very liquid and marketable.

Question 30

certificates of deposit (CDs)

Answer 30

short-term debt issued by banks with a minimum denomination of $100,000. they are insured to be default risk free up to $250,000 and less liquid than treasury bills.

Question 31

repurchase agreements

Answer 31

a loan arrangement whenin a securities dealer is the “borrower” and the investor is the “lender”. the investors buys securities from the securities dealer with an agreement to see them back to the dealer at a later date for a specified higher price. very little risk, as the security is collateral for the loan.

Question 32

banker’s acceptances

Answer 32

drafts written by the borrower and guaranteed by the bank on which the draft is drawn. typically used in international trade transactions; the borrower is an importer who writes the draft in payment of goods. very little risk because both the borrower and bank guaranteed the draft.

Question 33

commercial paper

Answer 33

short-term, unsecured debt issued by a large corporation. the minimum denomination is $25,000. the default risk depends on the creditworthiness of the issuing corporation.

Question 34

short-term tax exempts

Answer 34

short-term debt of state and local governments. these instruments pay interest that is exempt from federal taxation, so the pre-tax yield is lower than those of a similar-risk, fully taxable investment. the default risk depends on the creditworthiness of the government.