Working Capital Management Flashcards
(35 cards)
Define “working capital” (also called “net working capital”).
The difference between a firm’s current assets and its current liabilities; expressed as: Current assets - Current liabilities = Working capital.
Define “current assets”.
Cash and other resources expected to be converted to cash, sold, or consumed within one year (e.g., Accounts receivable, Inventory, some Prepaid items, etc.).
Define “current liabilities”.
Obligations due to be settled within one year or which will require the use of current assets to satisfy (e.g., Accounts payable, other short-term Payables, some Unearned revenue, etc.).
What is the objective of Working Capital Management?
To maintain adequate working capital so as to:
- Meet on-going operating and financial needs of the firm;
- Not over invest in net working capital which provide low returns or increase costs.
Give examples of over-investing in working capital.
- Maintaining excess cash in low-return accounts;
- Having excessive (large/old) accounts receivable which don’t earn interest;
- Maintaining more inventory than needed and thus incurring storage costs and increasing the risk of obsolete inventory.
Describe a payment through draft.
Payment is made with a legal instrument, called a “draft,” that is drawn on an account of a bank and is guaranteed payment by the bank. Examples include bank drafts, cashier’s checks, certified checks and money orders.
Describe the uses of zero-balance accounts.
A bank account with no real balance. Two variations exist:
- Checks written on account overdraw the account, but by agreement with the bank the overdrawn amount is paid automatically from another account.
- Only the known amount of payments from an account is deposited into the account (e.g., payroll account).
Define “float”.
The time between when a payment is initiated and when the related cash is available for use by the recipient.
Describe the operation of a lock-box system.
Customers remit payments to firm’s post office box where they are collected and then processed and deposited by firm’s bank; may reduce the float by several days.
Identify the advantages of using a lock-box system.
- Cash is available for use sooner than it would be if receipts were routed through the firm;
- Firm’s handling of collections is greatly reduced;
- Reduced likelihood of dishonored checks and earlier identification of those that are.
Describe the use of preauthorized checks.
Payment/collection of an amount due through the use of checks that are authorized in advance.
Describe concentration banking.
Funds collected in multiple local banks are transferred regularly and (usually) automatically to firm’s primary bank; used to accelerate the flow of cash to a firm’s principal bank.
What are the major considerations in selecting short-term securities as investments?
- Safety of principal;
- Price stability of the investment;
- Marketability or Liquidity of the investment.
Also, taxability, diversification, and cost of administration
What are United States Treasury Bills (also called T-Bills)?
Debt investment instruments that are the direct obligation of the U.S. Government; considered to be virtually risk-free and commonly used as the basis for the risk-free rate of return in many financial analysis.
Define “banker’s acceptance”.
A draft (or order to pay) drawn on a specific bank by a firm which has an account with the bank. If bank “accepts” the draft, it becomes a negotiable debt instrument of the bank.
Define “commercial paper”.
Short-term unsecured promissory notes issued by large, established firms with high credit ratings as a form of short-term financing (i.e., 270 days or less).
Define “repurchase agreement” (also called a “Repo”).
A debt investment instrument with a commitment by the buyer to resell the instrument to the seller at a specified price, which includes the original principal plus an interest or fee factor, at a specified time.
Define “default risk”.
A measure of the likelihood that the issuer will not be able to make future interest and/or principal payments to a security holder.
Describe the accounts-receivable management function.
Management functions concerned with the conditions leading to the recognition and collection of accounts receivables.
Identify the general credit-related factors that must be determined by an entity if it sells on account.
- Total period for which credit will be extended for sales on account;
- Discount terms, if any, granted for early payment of credit sales;
- Penalty for failure to pay according to credit terms;
- Nature and extent of documentation required for sales on account.
Identify two major approaches to determining a customer’s creditworthiness.
- Use of credit-rating service;
2. Financial analysis of prospective credit customer.
Identify some measures (averages and ratios) useful in assessing accounts-receivable management.
- Average collection period;
- Day’s sales in accounts receivable;
- Accounts receivable turnover;
- Accounts receivable to current or total assets;
- Bad debt to sales.
Describe an aging of accounts receivable schedule.
A schedule which shows for each credit customer how long each amount due from the customer has been owed. For example, amounts may be classified as being: not due, 1 - 30 days overdue, 31 - 60 days overdue, 61 - 90 days over due, over 90 days overdue.
Identify the central objective of inventory management.
To determine and maintain an optimum investment in all inventories. Under investing in inventory can result in shortages and lost sales; over investing in inventory can result in incurring excessive cost for inventory.
