Module 5 Flashcards by eunfaerie ˚ ༘♡ ⋆｡˚

This is the amount of current assets (financial management view) or current
assets net of current liabilities (accounting view) used to finance the firm’s short term
operations. This is the lifeblood of the business organization

Working Capital

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These are those convertible to cash w/in 1 year or normal operating cycle, w/c ever
is longer, to support operations like payment of short term obligations. It includes cash,
marketable securities, receivables, inventories and prepayments.

Current Assets

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These are current assets required to support fluctuations of the firm’s level of activity (volume of operations).

Temporary current assets

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These are current assets required to maintain normal operations.

Permanent current assets

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These are obligations to be paid within 1 year, thru current assets or incurrence of another liability. It includes trade payables, accrued expenses, short term debts and current portion of long term debts.

Current liabilities

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This refers to the efficient and effective utilization of financial manager.
working capital to attain organizational objectives related to: Profitability of operations, liquidity of financial resources, and the minimization of risks & company costs.

Working Capital Management

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These are the organizational objectives of working capital management.

Profitability of operations
Liquidity of financial resources
Minimization of risks & company costs

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What are the kinds of working capital policy?

Investment policy (Current assets)
Financing policy (Current liability)

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What are the working capital policies under investment policy?

Relaxed current investment policy
Restricted current investment policy
Moderate current investment policy

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This carries a relatively large amount of current assets. Sales is stimulated by liberated credit policy resulting to high level of receivables. The firm carries a large amount of inventory.

Relaxed current investment policy

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In this policy, current assets are minimized. The firm implements tight credit policy though it means running the risk of losing sales, holds minimal safety stock of cash and inventory, and works out the highest current asset turnover.

This entails the greatest risk but provides the highest expected ROI.

Restricted current investment policy

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This is the policy between relaxed and restricted.

Moderate current investment policy

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What is the least liquid current asset?

Inventory

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What are the policies under financing policy?

Conservative policy
Aggressive policy
Maturity matching policy
Balanced policy

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In this policy, almost all investment assets are financed by long term debts,
resulting to lesser amounts of short term debts. It reduces liquidity risk but also reduces profit due to greater financing costs.

Conservative policy

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This policy uses short term debts to finance, not only temporary but also part or all of the permanent current asset requirements. Thus, leading to greater amounts of short terms debts & lesser amount of long term debts.

It increases profits due to lesser financing costs of short term debts but also exposes the firm to liquidity risks due to low working capital position.

Aggressive policy

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It matches the maturities of obligations to the income (cash flow) generating characteristics of the assets financed. Long term debts are used to finance long term assets (permanent working capital) requirements while short term debts to finance short term assets.

Maturity matching policy

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This balances the trade-off between risk and profitability in a manner consistent with its attitude toward bearing risk.

Balanced policy

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What are the financing requirements?

Permanent requirements
Seasonal or temporary requirements

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This refers to property, plant & equipment (fixed assets) and permanent current
assets that must always be with the company throughout the year.

Permanent financing requirements

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These are additional requirements arising from fluctuation in the volume of
activity (production & sales) arising from seasonal changes in demand level for products during the year.

Seasonal (temporary) financing requirements

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What is the primary consideration in deciding the appropriate working capital policy?

The trade-off between risk (liquidity) and return (profitability)

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This is the appropriate mix of current and noncurrent assets

Asset mix decision

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This is the appropriate mix of short-term and long-term debts to finance current assets.

Financing mix decision

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This involves the maintenance of cash & marketable securities (MS) investment level which enhances the ability of the company to meet its cash requirements while maximizing the income on idle funds.

Cash management

What is the objective of cash management?

To attain the optimum cash balance

What are the reasons or motivations for holding cash?

1. Transactional motive 2. Contractual motive 3. Precautionary movie (safety stock) 4. Speculative motive

This motive is to facilitate normal transactions of the business. Examples are purchases, sales, payment of salaries, and payment of tax and dividends.

Transactional motive

This motive is to meet bank (creditor) requirements contained in a financing agreement. Example is maintaining compensating balance for a loan obtained in a bank.

Contractual motive

This motive is to provide buffer against contingencies like unexpected delay in collection of receivables & unexpected increases in disbursements due to inflation.

Precautionary motive (safety stock)

This motive is to take advantage of special income opportunities like: a. Purchase of large volume of inventories or fixed assets at much lower prices (bargain) b. To avail purchase discounts c. Purchase of high yielding securities

Speculative motive

How can cash availability be maximized?

By speeding up cash inflows and delaying cash outflows.

This is reducing the period between the time customers pay their bills & time the cash is reflected in company’s balances, ready for disturbances.

Managing (accelerating) collections

What are the modes of payment?

Cash basis Credit cards Checks

This mode of payment provides ready availability of cash and is mainly used in small retail goods.

Cash basis

This mode of payment offers a relatively longer time for cash availability than cash basis. It is mainly used in big retail & service establishments.

Credit cards

This mode of payment provides cash availability after “float period". It is mainly used in whole sale & high value consumer goods.

Checks

This float period is when customers payment reaches the company.

Mail float

This float period is when the company deposits the check to its depository bank.

Processing float

This float period is when depository bank make payments available to the company.

Clearing float

This is done by customers mailing their payments to a post office box in a specific city and the local bank collects and deposits them in the firm’s account.

Lockbox system

This is the control of cash payments.

Controlling disbursements

This is the money tied in the check clearing process; difference between the bank’s balance for a firm’s account and the firm’s book balance. It can be a combination of mail float, processing float and clearing float.

Float

This is knowing the appropriate level of cash to be maintained relative to MS.

Optimizing cash balances

This model is an inventory management (EOQ type) model developed by William J. Baumol which determines the optimal cash balance as the level where cost of holding cash is minimum.

Baumol Model

Who invented the baumol model?

William J. Baumol

developed by Mirton Miller & Daniel Orr which determines the optimal cash balance as the optimal return point for security transaction. It is used to address the unpredictability of cash disbursements, which is the major weakness of the Baumol model.

Probabilistic model

Who developed the probabilistic model?

Morton Miller and Daniel Orr

These are short term money market instruments that can easily be converted to cash.

Marketable securities

These are issued by BS & represents obligations of the national government.

Treasury bills

These are short term unsecured promissory note issued by corporations w/ very high credit standing. It is usually issued based on approval SEC.

Commercial papers

What are the most popular marketable securities?

Government securities Commercial papers Certificate of time deposits in commercial banks

What are the reasons for holding marketable securities?

To serve as substitute for cash balances To serve as temporary investment To meet financial requirements

This is the scaleability of the MS on short notice and at its approximate market value, incase of needs for cash.

Liquidity of MS

This is the probability that the borrower will be unable to pay interest and/or principal when they become due.

Default risk

This is the placement of excess funds only to acceptable institutions.

Accreditation

This is the probability that the intermediaries, not the issuer, will default.

Settlement risk

This arises from the volatility of interest rates.

Interest rate risk

This risk is a decline in the market value of investments.

Price risk

This is the risk that inflation will erode the purchasing power of money.

Inflation risk

This is the formulation and administration of plans and policies related to sales on account & ensuring maintenance & collectability of receivables at a predetermined level as planned.

Receivables management

This level of credit policy is related to customers and the credit and collection policies.

Policy level

This level of credit policy include the procedures and techniques to simplify and lower cost of implementing the credit and collection policy.

Administration level

Tighter standards tend to reduce sales, but reduce bad debt expense. Fewer bad debts reduce DSO.

Credit standards

Where is credit founded in?

Confidence

This is the aggregate of distinctive mental and moral qualities of the debtor, which indicates his willingness to pay his obligations on time, as promised. It denotes integrity.

Character

This is the ability of debtor to pay his obligations as indicated by income source.

Capacity

This is the excess of the debtor’s assets (properties) over his existing obligations, which will indicate the debtor’s capacity to pay additional obligation to be incurred.

Capital

This is an asset pledged by a debtor as security to creditors regarding payment of debt.

Collateral

These are the economic conditions greatly affect the capacity of debtors to pay their obligations.

Conditions

What are the 5 Cs of credit standards?

Character Capacity Capital Collateral Conditions

This is how long the AR is paid.

Credit period

This lowers price of products and attracts new customers and reduces DSO.

Cash discounts

These are strategies, organization and procedures for collection of receivables. It can be the use of collection agencies, sales man as collectors, keeping of records, billing, follow up procedures, etc...

Collection programs

This is whatever credit policy a firm may adopt, there will be some customers who might delay or entirely default in payment.

Delinquency and default

This is the overall way a company oversees its inventory and uses its control system to manage the benefits against the cost of carrying inventory.

Inventory management

This the overall way a company oversees its inventory and uses its control system to manage the benefits against the cost of carrying inventory.

Inventory management

This is the determination of the quality, quantity and location of inventory, as well as the time of ordering in order to meet future business requirements.

Inventory planning

This is the order size which minimizes the total inventory related costs.

Economic order quantity (EOQ)

These costs includes opportunity costs, storage and handling costs, property taxes, depreciation, spoilage and obsolescence.

Carrying costs or holding costs

These are the costs of placing orders, shipping, and handling costs

Ordering costs

This is the volume size or quantity of goods per purchase order.

Order size

This is the additional supply of inventory that is carried all the time to be used when normal working stocks run out. It is held to avoid shortages.

Safety stock

This is the inventory level at which new inventories must be ordered.

Reorder point

This is the period of time on which an order to the supplier must be done in advance.

Lead time

A management philosophy which requires that all resources be acquired and used only as needed. This is known as Toyota production system.

Just in time (JIT) system

This is the regulation of inventory within predetermined level. Adequate stocks should be available to meet business requirements but investment in inventory is minimized.

Inventory control

In this system, an order for a fixed quantity is placed when the inventory level reaches the reorder point.

Fixed order quantity system

This system is when orders are made after a review of inventory levels has been done at regular intervals.

Fixed reorder cycle system

This is the approach in tracking inventories wherein the inventories are classified according to their degree of significance.

ABC system

These result to lost contribution margin on the sales opportunities, loss of customer goodwill and disruption of production schedules. It is also referred to as third type of inventory costs called cost of running short

Stock outs

These result to unnecessary carrying costs.

Overstocks