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Finance > working capital management > Flashcards

working capital management Flashcards

1
Q

what is working capital

A

referring to current assets

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2
Q

what is net working capital

A

difference between current assets and current liabilities

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3
Q

why is net working capital important?

A

measure of the firms liquidity (ability to meet current obligations as when they fall due, using current assets)

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4
Q

what does a positive and negative NWC mean

A

high liquidity and low liquidity

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5
Q

reasons that wcm is important

A
  • lack thereoff affects a firm’s profits and cash flows
  • assesses a firm’s liquidity or short term solvency (ability yo pay current liabilities as when they fall due - done with the current and quick ratios)
  • helps us assess how efficient the firm is in managing its current assets and current liabilities
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6
Q

what is the days inventory on hand ratio

A

how long inventory stays on the shelf - measuring efficient management of inventory

inventory (end of year)*365/cost of sales

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7
Q

what does an increase in the day inventory on hand ratio mean?

A

less efficient management of inventory

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8
Q

what is the accounts receivable collection period

A

how long it takes debtors to pay

trade receivables(end of year)*365/turnover or sales

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9
Q

what does a decrease in debtors collection period mean

A

debtors paying back sooner

better management of trade receivables

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10
Q

what are possible risks of improving debtor’s collection period

A

loss of customers

reduction of sales

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11
Q

what is account payables days

A

the amount of days that it takes us to pay creditors

trade payables*365/cost of sales

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12
Q

when is a reduction in creditors collection period good and when is it bad

A

good - exceeded creditors agreed period or taken advantage of early settlement discounts or cash discounts

bad - when the firm isnt taking advantage of discounts or hasnt exceeded credit terms yet

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13
Q

what is the operating cycle

A

the time between purchasing inventory and the collection of cash from debtors (internet definition: An operating cycle is the amount of time a company spends between spending money operating activities and collecting money from the same operating activity. Operating cycle often focus on the purchase and sale of assets)

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14
Q

formula for op cycle

A

days inventory on hand + accounts receivable period

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15
Q

what is the cash conversion cycle?

A

time period between the receipt of cash from the debtors and paying the creditors

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16
Q

formula for ccc

A

operating cycle - creditors collection period

17
Q

what does a zero CC mean?

A

creditors are paid as soon as we receive cash from debtors - creditors are fully financing inventory and debotrs

18
Q

what does a positive ccc mean

A

creditors are paid before debtors pay us - the company needs funds to finance inventory and debtors - creditors and company are both financing inventory and debtors

19
Q

what is does a negative ccc means

A

detbors pay pay us before payment to creditors is due - creditors are fully financing debtors and inventory. Since cash is received before creditors is due - we invest it to earn interest

20
Q

what is the conservative wcm strategy?

A
  • high current assets to sales ratio
  • less short term debt
  • lots of long term debt
  • net working capital is positive
  • less financial distress
  • high carrying costs - storage, security, bad debts
  • low shortage costs
21
Q

what is the aggressive wcm strategy

A
  • lowcurrent assets to sales ratio
  • more short term debt
  • less long term debt
  • net working capital is negative
  • low liquidity
  • more financial distress
  • low carrying costs - storage, security, bad debts
  • high shortage costs
22
Q

what are the costs of carrying too much or too little inventory

A

little - shortage costs

much - carrying costs

23
Q

what happens when inventory increases and decreases

A

increase: shortage cost increase and storage costs decrease
decrease: shortage cost decrease and storage costs increase

24
Q

what are the inventory management techniques

A

abc
twin bin
economic order
just-in-time

25
Q

what is the abc technique

A

three groups of classified inventory:
- A - high values, low quant, close monitoring
- B - moderate value moderate quantity
C - low value high quantity

26
Q

what is the twin bin technique

A

two bins for each type of inventory

  • large bin for bulk stock and a smaller bin with enough stock to last the restocking period
  • as soon as the stock in the large bin is sold out order is placed and goods are sold from the smaller bin
  • new stock enough for both bins - new cycle begins
27
Q

what is the economic order quantity technique

A

mathematical model that determines the appropriate amount of inventory needed so as to minimize shortage and carrying costs

28
Q

what is the just in time technique

A
  • suppliers deliver raw material just in time for it to be used on the production line - ensures that no inventory of raw materials is kept
29
Q

what are the advantages and disadvantages of granting credit

A

+: increases sales

- : increased exposure to bad debts

30
Q

components of a credit policy

A 
terms of credit sales
- credit period
- cash settlement discount 
credit analysis
collection policy
31
Q

what are the costs of granting credit

A
  • carrying costs
  • shortage costs
  • if liberal credit policy - increase is carrying costs
  • if restrictive credit policy - increase in shortage cost
32
Q

what is credit analysis

A

done before granting credit to a customer - cathering relevant info, determining credit worthiness

33
Q

how is credit worthiness determined

A

5 C’s of credit evaluation

credit scoring system

34
Q

what are the 5 C’s of credit eval

A

character - willingness to meet financial obligatons
capacity - ability to meet financial positions
capital - financial worth or reserves
collateral - assets pledged as security
conditions - general economic conditions

35
Q

what is credit scoring

A

deciding to grant credit based on customer’s rating

36
Q

what does the collection policy entail

A

continuously monitoring accounts receivables
- keep an eye on average collection period relative to credit terms
- use an aging schedule to determine percentage of receivables that are late in payment
having a collection procedure

37
Q

what are the reasons for holding cash?

A

speculative motive - hold cash to take advantage of unexpected opportunities
precautionary motive
transaction motive - to pay day to day things

38
Q

what cost is incurred by a firm when it holds excess or substantial amounts of cash

A 
opportunity cost
(interest income foregone)

Finance (12 decks)

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