Chapter 3 - Financial Management+CapitalBudgeting Flashcards
(56 cards)
Five manin functions of financial management
Know these
Cash Conversion Cycle (2-4)
’s 2-4, which is the time from when a business pays for its inputs to the time it collects cash in the end. Goal is to SHORTEN CCC. Shortening CCC improves profitability. Longer CCC’s require busineses to use more financing rather than rely on cash flow
Inventory Conversion Period (1-3)
Stages 1-3, which is the time it takes for inventory to be purchased to the time it takes to be sold (NOT cash collection, just a sale).
Inventory Turnover = COGS/Average Inventory
Inventory Conversion Period = 365/Inventory Turnover
A/R Collection Period (3-4)
Stages 3-4. The time it takes from a sale to be collected into cash.
Accounts Receivable Turnover = Sales/Average Accounts Receivable
Receivables Collection Period (Days Sales Outstanding) = 365/Accounts Receivable Turnover
A/P Deferral Period (1-2)
Stages 1-2, measuring the time it takes from purchasing invy (and recording the payable) to paying suppliers for it.
Accounts Payable Turnover = Sales/Average Accounts Payable
Accounts Payable Deferral Period = 365/Accounts Payable Turnove
CCC=
Cash Conversion Cycle = Inventory Conversion Period + Receivables Collection Period – Payables Deferral Period
Float
The time it takes for checks to be mailed, processed, and cleared
How to manage float
Think about it: the longer the float the worse if it’s a receivable. We wouldn’t want our check to take long to convert.
And the opposite goes for if it’s a payable. We would rather have the money stay in our account as long as possible. Just be sure you don’t spend it all ;)
So:
MAXIMIZE float payment time
MINIMIZE float receivable time
Reorder point.
level of inventory which triggers replenishment that particular inventory stock
Reorder point calculation
Average Daily Demand
xAverage Lead Time
= Amount to reorder
+Safety Stock
Reorder point
- Average Lead Time is the # of days it takes a supplier to deliver the goods once an order is placed
- Safety stock - see seperate card
Safety Stock
An amount to reorder in additon to the reorder point of inventory. To be held just incase.
Calculated as the difference between Average Daily Demand Multiplied by the average and max lead time
EG:
- We sell 25 per day average
- Average lead time is 10 days
- Maximum lead time is 15 days
25 ADP x 10 days = 250
25ADP x 15 days = 375
375 - 250 = 125 Safety Stock
Economic Order Quantity
Economic order quantity (EOQ) is the order quantity that minimizes the total inventory holding costs and ordering costs
Economic order quantity (EOQ) Formula, and a disadv of it
EOQ = SQRT(2AP/S)
A = Annual (i.e., periodic) demand
P = cost to place an order,
S = cost to store inventory (carrying cost)
One problem with EOQ is that it assumes the periodic demand is known
Capital Budgeting
Techniques that, with the information availible, try to select the most profitable or best investment in a set of alternatives.
4 capital budgeting techniques BEC likes to test
- Payback Period
- Internal Rate of Return
- Accounting Rate of Return
- Net Present Value
PAyback Period
Tries to guesstimate the average time it might take for an investment to be recouped. It’s easy to understand and deals with cash flows,so people like it. But it does not take into account:
- Time Value of Money. Assumes each yearly cash flow are the same value - not PV’d
- Profitability - only tells time
Payback Period Formula
Initial investment or cash outflow
After-tax net cash inflows per year
IRR Formula
Initial investment or cash outflow
After-tax net cash inflows per year
Yes - same as payback period. Then:
(say the # is 6.4)
- Look at the PVOA table
- Go down to the # of years the project is
- Look across and find the closest value there is to that 6.4.
- Look up the interest rate it belongs to. That rate is the IRR
IRR
Internal Rate of Return. You can think of IRR as the rate of growth a project is expected to generate. It would be compared to other investments or to a hurdle rate
Hurdle Rate
Minimum acceptable rate of return. Can be whatever the company sets it to be, but its usually WACC or derived from market rates of return for similar projects.
Accept a project IF THE IRR IS HIGHER THAN THE HURDLE RATE.
Advantages and Disadvantages of IRR
ADV:
- Account for TVM
- more understandable then Net Present Value
DISADV:
- estimates can always be wrong, so cash flows can yield multiple IRRs.
Accounting Rate of Return (ARR)
Accounting Income
Average or Initial Investment
***Accounting Income is typically profits less depreciation
ARR disadvantages and advantages
ADV:
Easy to understand
Can rate managerial performance
DISADV:
No TVM taken into account
different depreciation methods obviously would yield different ARR’s
