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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.
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What is negative arbitrage?
When interest obligations (paying on an 8% loan) exceed interest income (receiving 2% from a bank account)
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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).
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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
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What is the formula for A/R Days Sales Outstanding?
- A/R Turnover = Sales / Avg AR balance
- Days Sales Outstanding = 365 / AR Turnover
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What are two non-credit methods to expedite receipt of cash & deposits?
- Use of Electronic Funds Transfer (EFT)
- Use of a lockbox
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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.
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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.
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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.
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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)
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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.
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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.
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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.
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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.
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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
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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
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