Unit 7: Working Capital Management

Question 1

Net working capital
(Formula)

Answer 1

Current Assets - current liabilities

Question 2

Working capital policy applies to —— term decisions, capital structure applies to ——- term decisions

Answer 2

Short ; long

Question 3

Permanent working capital

Answer 3

The minimum level of current assets maintained by a firm.

Question 4

Conservative working capital policy

Answer 4

Keeps a high amount of working capital. Current ratio will be high

Question 5

Aggressive working capital policy

Answer 5

Increase profitability by accepting reduced liquidity. Low current ratio.

Question 6

3 motives for holding cash

Answer 6

1) transactional
2) precautionary
3) speculative

Question 7

Annual Benefit : Reducing the float time of cash receipts
(formula)

Answer 7

(Daily cash receipts x Days of reduced float) x Opportunity cost of funds

Question 8

Money market mutual funds invest in ____ term ____ risk securities

Answer 8

Short ; Low

Question 9

________ are time deposits of U.S. dollars in banks located abroad

Answer 9

Eurodollars

Question 10

________ are a form of savings deposit that cannot be withdrawn before maturity without a high penalty.

Answer 10

CDs

Question 11

_________ consists of unsecured, short-term notes issued by large companies that are very good credit risks.

Answer 11

Commercial Paper

Question 12

_______ are drafts drawn by a nonfinancial firm on deposits at a bank.

Answer 12

Banker’s acceptances

Question 13

__________ are a means for dealers in government securities to finance their portfolios. Firm’s purchase government securities temporarily (few days) from a dealer.

Answer 13

Repurchase agreements (repos)

Question 14

T-Bill maturity & interest

Answer 14

1 year or less ; note is sold at discount and interest paid at maturity. no interest rate.

Question 15

T-notes maturity & interest

Answer 15

1 - 10 years; interest every 6 months

Question 16

T-bonds maturity & interest

Answer 16

10 years + ; interest every 6 months

Question 17

Payment Float
(Define)

Answer 17

the period from when the payor writes a check until the funds are subtracted from the payor’s account.

Question 18

Formula for assessing the increased investment in A/R

Answer 18

Incremental variable cost x (incremental avg collection period/360)

Question 19

What is factoring

Answer 19

Transfer of receivables to a 3rd party who assumes the responsibility of collection

Question 20

What is a pledge

Answer 20

The use of receivables as collateral for a loan. Borrower agrees to use the collections to repay the loan

Question 21

The objective of working capital finance is

Answer 21

To minimize the cost of maintaining liquidity (quick convertibility to cash to pay current obligations) while guarding against the risk of insolvency (inability to pay obligations as they come due).

Question 22

Two means of speeding up cash receipts are

Answer 22

Lock box and concentration banking

Question 23

Define the cash conversion cycle

Answer 23

the time that passes, on average, between the firm’s payment for a purchase of inventory and the collection of cash from a customer on the sale of that inventory

Question 24

What are two different formulas that can be used to calculate average accounts receivable?

Answer 24

All of the following formulas can be used to calculate average accounts receivable:
(Beginning A/R + Ending A/R) ÷ 2
Daily credit sales × Average collection period
Net credit sales × (Average collection period ÷ Days in year)
Net credit sales ÷ Accounts receivable turnover

Question 25

What formula is used to calculate the cost of a change in credit terms?

Answer 25

Increased investment in receivables × Opportunity cost of funds

Question 26

What are the four costs related to inventory?

Answer 26

The four costs related to inventory are
Purchase costs
Carrying costs
Ordering costs
Stockout costs

Question 27

What are carrying costs?

Answer 27

Carrying costs, which are associated with holding inventory, include
Storage,
Insurance,
Security,
Inventory taxes,
Depreciation or rent of facilities,
Interest,
Obsolescence and spoilage, and
The opportunity cost of funds invested in inventory.

Question 28

Define ordering costs

Answer 28

Ordering costs are the costs of placing an order with a vendor. They are independent of the number of units ordered

Question 29

What is the formula to calculate the reorder point?

Answer 29

(Average demand × Lead time) + Safety stock

Question 30

What is the formula to calculate the total cost of carrying safety stock?

Answer 30

Cost of carrying safety stock = Expected stockout cost + Carrying cost

Question 31

Describe a kanban inventory system

Answer 31

Under a kanban system, tickets control the flow of production. The tickets contain production information related to various stages of production to improve the overall production process.