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Chapter 16 final exam
Terms in this set (76)
what is Net Working Capital? (equation)
NWC=Current Assets-Current liabilities
What is liquidity?
ability to meet cash obligations
what is the importance of working capital?
Firms must have working capital to survive
current assets make up a large percentage of total assets
what is the difference between the a firm's operating cycle and their cash conversion cycle?
operating cycle- buy materials and collect cash from product
cash conversion cycle-pay for what you brought to sales you make
(cash conversion cycle is inside the operating cycle)
different parts of operating cycle
1. inventory conversion period
2. receivables conversion period
3. payable referable period
4. cash conversion cycle
inventory conversion period
the length of time required to produce and sell the product
Inventory conversion period equation
Inv conv Per=Average Inventory /cost of sales /365
What is the receivables conversion period?
represents the the length of time required to collect the sales receipts
receivables conversion period equation
rec conv per=avg accounts receivable/ annual credit sales /365
what is the payable deferral period?
the length of time the firm is able to defer payment on various resource purchases (materials)
the payable deferral period equation
payable def per=average accounts payable /cost of goods sold/365
cash conversion cycle
the time interval between the collection of cash receipts and the product sales and the cash payments for the company's various resource purchases
what is the cash conversion cycle equation?
cash conv cycle=operating cycle -payables deferral period
What is the operating cycle?
1. purchasing resources
2. producing the product
3. and selling the product
Equation for Operating cycle
op cycle=inv con period +rec con period
size and nature of current assets depends on:
-type of product
-length of operating cycle
-efficiency of management of current assets
conservative working capital inv
Aggressive working capital
what is the optimal level of working capital?
the level expected to to maximize shareholder wealth ( no single policy for all firms)
cost of short term vs long term debt
-the difference in interest rates on debt
-the effective cost of long term debt may be higher than the cost of short term debt
risk of long term debt vs short term debt
- risk of not being able to to refinance short term debt
-short term rates are more volatile (fluctate more) than long term debts
what are the two categories of current assets?
permanent and fluctuating
permanent current assets
meet minimum long term needs (safety stocks of cash and inventories)
fluctuating current assets
affected by seasonal or cyclical nature of sales (making more at peak selling periods)
what are the three diff strategies of current assets?
matching, conservative, aggressive
what is the matching approach for asset financing?
the maturity structure of the firm's liabilities is made to correspond exactly to the life of its assets
(only use short term debt for fluctuating current assets
What is the matching approach to asset financing
only use the short term debt to finance only a little of the fluctuating current assets (making sure you have the money)
What is the aggressive approach for asset financing?
short term debt also covers permanent assets and well as the fluctuating current assets
What are secured assets
That means they are back backed up by tangible assets
what is a security agreement?
contract between lender and borrower specifying the collateral against the loan
An asset that a bank hold as security for the repayment of a loan
cash flow lenders
future cash flows are a primary source of repayment and the borrowers assets are a secondary source of of repayment (primary cash source)
asset base lenders
place greater emphasis on value of collateral (inventory and machine expenses)
sources of short term credit spontaneous
sources of short term credit negotiated sources
what are the two cost of short term funds?
AFC (Annual financing cost) and APR (annual percentage rate)
or the nominal annual interest rate is the simple interest rate
AFC=interest cost+fees /usable funds X365/ days till maturity
Effective annual percentage rate is a rate that that includes the effect of compounding
ieff=EAPR=( 1+interest costs +fees /usable funds)^m - 1
What is trade credit?
when a business receives merchandised ordered from a supplier and then is permitted a period of time before having to pay
Open account basis
when a firm sends purchase order to a supplier who then evaluates the firms creditworthiness using various info sources and dec criteria
which specifies the amount to be paid and the due date is formally recognizing an obligation to to repay the credit
what are the credit terms of trade credit?
length, beginning date, cash discount, special terms (seasonal date)
cost of trade credit (equation)
AFC=% of discount/100 - % of discount X 365/ credit period-discount period
stretching accounts payable
-postponing payment of the amount due to beyond the end of the credit period
-May make it difficult to obtain trade credit in the future!!
-Late fees might also come into effect
different types of accrued expenses
what is deferred income?
payments received for goods and services that the firm has to agreed to deliver at some future date (are advanced payments and increase liquidity and assets)
the rate banks usually use for their most creditworthy customers
London interbank offered rate (LIBOR)
the interest rate at which banks in the Euro-currency market lend to each other
single loans (notes)
bank loan needed for a short term period
Lines of credit
an agreement that permits the firm tot borrow funds up to a predetermined limit at any time during the life of the agreement (usually one year)
revolving credit agreements
the bank is legally committed to making loans to a company up to the predetermined credit limit specified in the agreement (commitment fee)
the bank deducts the interest at the time the loan is made and the borrower does not receive the full loan amount
certain percentage normally in the range of 5 to 20 percent of a loan balance that the borrower keeps on deposit with a bank as a requirement of a loan made by the bank
protective covenants and cleanup period
provision requiring that the company have no loans outstanding under the line of credit for a certain period of time each year, usually 30 to 90 days
what is the different between a line of credit and a revolving credit agreements?
the fees and the strictness to follow
equation for the revolving credit agreements
AFC=interest costs + commitment fee/usable funds X 365/ maturity days
short term unsecured promissory notes issued by major corporations
four fun facts of commercial paper
issued by well known companies
maturities up to 270 days
sold at discount
there is a placement fee
Equation for commercial paper
AFC=interest costs +placement fee/ usable funds X 365/maturity days
who purchases commercial paper?
individuals, corporations, banks, insurance companies, pension funds, money market funds
what are the two types of accounts receivable loans
pledging and factoring
pledging accounts receivable
firm retains title to the receivables and continues to carry them on its balance sheet
factoring accounts receivable
involves the outright sale of the firms receivables to a financial institution known as a factor
the factor assumes the risk of default
selling acc rec after the last day the customer could have taken the to pay this.....frustrated and needed the money
selling the acct rec as soon as they are are created
what are the three types of inventory loans?
raw materials, work in progress, and finished goods
The inability of services to be stored, warehoused, or inventoried
lender receives a security interest or general claim on all of the firms inventory
the firm holds the inventory and proceeds from the sale in trust for the lender
terminal warehouse financial agrangment
inventory being used as a loan collateral is stored in a bonded warehouse operated by a public warehousing company
field warehouse financing arrangment
inventory that serves as collateral for a loan is segregated from the firms other inventory an stored on its premises under the control of a field warehouse company
what is the most important source of short term financing for business firms in the aggregate?
what is the major source of negotiated short term funds?
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