What is the primary focus of working capital management?
Managing inventory & receivables (current assets & liabilities)
How is Net Working Capital calculated?
NWC : Current Assets - Current Liabilities
What are the characteristics of effective Working Capital Management?
Shorten the cash conversion cycle
Don't negatively impact operations
What is the Inventory Conversion Period?
Average time needed to convert materials into finished goods and sell them
Average Inventory : (BI + E) / 2
Inventory Conversion Period : Average Inventory / Sales Per Day
What is the Receivables Collection Period?
Average time needed to collect A/R
RCP : Average Receivables / Credit Sales Per Day
What is the Payables Deferral Period?
Average time between materials and labor purchase and their A/P payment
Average Payables : (BP + EP) / 2
Payables Deferral Period : Average Payables / (COGS/365)
What is the Cash Conversion Cycle?
Amount of time it takes to receive a cash inflow (Customers) after making a cash outflow (Vendors)
Inventory Conversion Period + Receivables Collection Period - Payables Deferral Period : Cash Conversion Cycle (Inventory Really (-Pays) Cash)
What traits should Cash and Short-Term Investments have?
For what are Letters of Credit used?
Used for importing goods. Issued by importer's bank.
What is the advantage of using Trade Credit?
No interest cost if paid timely.
What is a Lockbox System? What are the advantages?
Customer Payments are sent to a bank-managed PO box.
Employees don't have access to cash.
Deposits are more timely.
Interest income from deposits should pay for the Lockbox fees (if they don't- lockbox is not beneficial)
What is float?
Time it takes to mail a payment and have it clear your bank account
Maximize float on cash payments
Minimize float on cash receipts
What are Zero Balance Accounts?
Regional bank sends enough cash to cover daily checks
Checks take longer to clear -more float
Low amounts of cash tied up for compensating (minimum) balances
What is the difference between Treasury Bills- Notes and Bonds?
Treasury Bills: Short term (less than one year) Think: $1 Bill Treasury Notes: Medium term (less than 10 years- more than 1) Treasury Bonds: Long term (greater than 10 years) Think: government is in long-term bondage to you; they owe you money
What is commercial paper?
Similar to T-Bill- but issued by corporations instead of Government
Greater than 9 Months Maturity
Issued by large firms
What are the advantages and disadvantages of Commercial Paper?
Financing at less than Prime.
No compensating balances required.
Unpredictability of markets.
Credit crisis emerges and large insurance/investment companies aren't lending.
What is Economic Order Quantity?
The order quantity that minimizes inventory costs.
EOQ : Square Root of (2DO/C)
D : Unit Demand (Annual)
O : Order Cost
C : Cost of Inventory
What is Carrying Cost?
The cost of keeping inventory.
What is Order Cost?
Cost of executing an order and starting product production.
What is inventory reorder point?
How low inventory should get before it should be re-ordered.
IOP : Average Daily Demand x Average Lead Time
What is a Just In Time (JIT) system?
Orders inventory so that you get it just in time for when it's needed JIT is valuable when Order Cost is low and Cost of Carrying Inventory is high
What is Factoring of receivables?
Receivables are sold to a financing company where they pay less than the value of the receivables due to a discount related to risk of non-collection
What is a Trade Discount?
Buyer saves if paid early
Example: 1/10 Net 30 1%
Discount if paid within 10 days
If not- bill is still due in 30 days
What is the cost of forgoing a discount?
(Discount % x 365) / ((100% - Discount) x (Pay Period - Discount Period))
What is the Prime Rate?
A benchmark used for lending only to the best customers
Most customers will be charged Prime + 3%- for example
If the lending institution and the customer are not in the same country- the LIBOR rate is often used
What is the Nominal (Face- Coupon- Stated) Rate?
Interest rate stated on the face of a bond.
How is Current Yield calculated?
CY : Interest Payment / Bond Price
What is the Effective (YTM- Market) Rate?
PV of Principle + Interest : Bond Price
What is a Zero Coupon Bond?
No interest payments made
Bond sold at a discount
Interest reflected when Bond matures
What are the characteristics of a Junk Bond?
High interest rate
High default risk
What are debenture bonds?
Bonds unsecured by collateral
What are subordinated debentures?
Debenture Bonds that will be repaid if any assets are left after liquidation of a company
What are Redeemable Bonds?
Provision in Bond contract allows demand of Bond payment under certain circumstances
What is a Callable Bond?
Borrower can pay off debt early
What is a Convertible Bond?
Lender can demand payment via company stock instead of money
What is a Sinking Fund?
Borrower deposits regular sums into an account that will eventually pay off the debt
What is the disadvantage of Common Stock in comparison to bonds?
Common Stock is more expensive to issue than debt.
Why? Investors demand a greater ROI than debtors (bondholders)
What is the advantage of Preferred Stock?
Hold dividend priority over common stock
What is Weighted Average Cost of Capital?
A company uses this to determine the true cost of their capital Example:
Debt costs 5%; 40% of Cap.
Equity costs 12%; 60% of Cap.
(5% x 40%) + (12% x 60%)
WACC : 9.2%
What is CAPM?
A stock's expected performance is based on its beta (risk) compared to that of the stock market.
More risk : more expected return.
How is Cost of Debt calculated?
(Interest Expense - Tax Benefit) / Carrying Value of Debt