What is the primary focus
of working capital management?
Managing inventory & receivables (CA + CL)
How is Net Working Capital calculated?
NWC = CA - CL
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?
Sales Per Day
Avg time needed to convert DM to FG & sell them
What is the Receivables Collection Period?
Daily Credit Sales
Avg time needed to collect AR
What is the Payables Deferral Period?
Avg Payables / (COGS/365)
Avg time b/t materials and labor purchase and their AP payment
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 Paymts sent to a bank-managed PO box
- Employees don't see cash
- Deposits more timely
- Interest income from deposits pays for Lockbox fees
What is float?
- Time it takes to mail payment & clear bank acct
- Maximize float on cash payments
- Minimize float on cash receipts
What are Zero Balance Accounts?
What are the advantages?
Regional bank sends enough cash to cover daily checks
Advantages: Checks take longer to clear, more float
Low amounts of cash tied up for compensating (minimum) balances
What is the difference between
Treasury Bills, tNotes and tBonds?
Treasury Bills: Short term (< 1 yr) i.e. $1 Bill
Treasury Notes: Med term (1 - 10 yrs)
Treasury Bonds: LT (10+ yrs)
Govt in long-term bondage to you; they owe you money
What is commercial paper?
- Similar to T-Bill- but issued by corps
- Greater than 9 Months Maturity
- Issued by large firms
What are the advantages
and disadvantages of Commercial Paper?
Advantages: Financing at less than Prime.
- No compensating balances required.
Disadvantages: Unpredictability of markets.
- Credit crisis emerges and large ins/investmt 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?
Avg Daily Demand x Avg Lead Time
Minimum inventory before re-ordering.
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 = low
and Cost of Carrying Inventory = high
What is Factoring of receivables?
Receivables are sold to a financing company that pays 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
- Ex: 1/10 Net 30
- 1% Discount if paid in 10 days
- Reg price 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%
Ex: If the lending institution & customer are not in the same country, the LIBOR rate often used
What is the Nominal (Face- Coupon- Stated) Rate?
Interest rate stated on the face of a bond.
How is Current Yield calculated?
What is the Effective (YTM- Market) Rate?
PV of Principle
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
Ex: Debt costs 5%; 40% of Cap.
Equity costs 12%; 60% of Cap.
(5% x 40) + (12% x 60)
= 2 + 7.2
WACC = 9.2
What is CAPM?
- A stock's expected performance
- 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