BEC 2 - Working Cap Mgmt 2

  1. A company's credit policy regarding accepting customers for A/P [is / is not] a major determinant of demand for a firm's products?
    It is a major determinant as short-term credit is the major source of short-term funding used by small businesses.
  2. What is negative arbitrage?
    When interest obligations (paying on an 8% loan) exceed interest income (receiving 2% from a bank account)
  3. When managing cash and cash equivalents, the general rule is to [lengthen / reduce] the operating cycle, but [lengthen / reduce] the A/P cycle.
    Reduce the operating cycle (time it takes to sell inventory and receive the cash for the sale), and lengthen the AP cycle (time it takes to pay suppliers/vendors).
  4. What four variables affect a company's credit policy?
    • Credit period = length of time customers are given to pay
    • Credit Standards = the financial strength of the customer who will be accepted for credit
    • Collection Policy = how stringent or lax in collecting on delinquent accounts
    • Discounts = the percentage and period used for an incentive to speed receipt
  5. What is the formula for A/R Days Sales Outstanding?
    • A/R Turnover = Sales / Avg AR balance
    • Days Sales Outstanding = 365 / AR Turnover
  6. What are two non-credit methods to expedite receipt of cash & deposits?
    • Use of Electronic Funds Transfer (EFT)
    • Use of a lockbox
  7. What is factoring?
    Selling A/R to a firm (a "factor) to receive cash quickly. The Factor is then responsible for collecting the A/R.
  8. What is a Letter of Credit?
    A third-party guarantee (usually from a bank) of financial obligations incurred by the company. It's used by the company to obtain better interest rates for non-secured financing.
  9. What is a Line of Credit?
    A revolving loan with the bank, typically used to cover short-term cash payments while leaving the company's cash reserves untouched.
  10. What are debt covenants? What types of debt covenants are there? How are they used?
    • Lenders may impose limitations on a company to protect their investment (debt covenant).
    • Negative covenants are restrictions or limitations (no addl debt, no dividend payments, limit how the borrowed money is used).
    • Positive covenants involve minimums or maintenance items (min. bank balance, max. debt-to-capital ratio, providing copies of bank statements)
  11. What are the potential consequences of a violation of a debt covenant?
    The company would be in "technical default" and the creditor can demand immediate repayment of the entire principal.
  12. Short-term financing matures within which time period and thus affects which ratios the most? What are the advantages / disadvantages of ST financing vs LT financing?
    • =< 1 year
    • Affects working capital, working capital ratio (measures of liquidity)
    • Advantages: Preferred due to lower interest rates (less risk due to time factors).
    • Disadvantages: (1) Interest rates shift frequently; LT rates may be lower over a longer period of time. (2) Impacts liquidity.
  13. Long-term financing matures within which time period and thus affects which ratios the most? What are the advantages / disadvantages of LT financing vs ST financing?
    • >1 yr maturity
    • Affects debt-to-[equity, assets, etc] ratios
    • Advantages: decreased interest rate risk b/c it's locked in for a longer time. Decreased liquidity risk as payments are known.
    • Disadvantages: Decreased profitability due to higher initial interest rate.
  14. Define Collection Float. Which is better, more or less float?
    • The time that elapses between when a check is deposited into a bank account and when the funds are available to the depositor.
    • A shorter (less) float time is better.
  15. WHITE BOARD: CompanyA's variable cost ratio is 70%, and its required rate of return is 12%. If sales increase from $360,000 to $432,000, but the avg A/R collection period increases from 30 to 40 days, what is the cost of carrying the additional A/R?
    • Old: $360,000 x 70% x 12% x (30/360 days) = $2,520
    • New: $432,000 x 70% x 12% x (40/360 days) = $4,032
    • Difference: $1,512
  16. WHITE BOARD: Credit terms are 1/15,n30. 40% pay on the discount date, 40% on the next due date, 20% 15 days after the next due date. What is the project days sales outstanding?
    • 40% x 15 = 6 days
    • 40% x 30 = 12 days
    • 20% x 45 days = 9 days
    • Total = 27 days
Card Set
BEC 2 - Working Cap Mgmt 2
Becker Review