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BEC7 - Working Capital Management


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What is working capital management?
Managing and financing current assets and current liabilities.
What is the primary focus of working capital management?
The cash conversion cycle of the firm.
What is the cash conversion cycle?
The length of time between when the firm makes payments and when it receives inflow.
Name the three components of the cash conversion cycle.
1. inventory conversion period
2. receivables collection period
3. payables deferral period
Describe the inventory conversion period.
The average time required to convert materials into finished goods and sell the goods.
What is the inventory conversion period?
The average time required to convert materials into finished goods and sell the goods.
What is the receivables collection period?
The average time required to collect accounts receivable.
What is the payables deferral period?
The average time between the purchase of materials and labor and payment of cash for them.
Describe cash management.
Holding the minimum amount of cash to meet the firm's needs.
Name the two purposes for holding cash.
1. for transacting business
2. as compensation for financial institutions
What is the float?
The time that elapses relating to mailing, processing, and clearing checks.
What is management's objective with regards to the float?
To minimize the cash receipts float and maximize the cash disbursements float.
How can management increase the cash disbursements float?
A zero-balance account.
What is a zero-balance account?
A regional bank account to which just enough funds are transferred daily to pay the checks presented.
Name three techniques for decreasing the cash receipts float.
1. a lock-box system
2. concentration banking
3. electronic funds transfer
Describe a lock-box system.
Customer payments are sent to a post office box that is maintained by a financial institution.
Describe concentration banking.
Customers make payments to a local branch office rather than firm headquarters, and the branches make deposits to local banks.
Describe electronic funds transfer.
A system in which funds are moved electronically between accounts without the use of checks.
Describe a cost-effective cash management technique.
Interest savings by having use of the funds longer offset the increase in maintenance charges and fees.
Why do firms hold marketable securities?
As a cash reserve.
Name the two major considerations with respect to the nature of investments.
Liquidity and safety.
Name seven types of investments.
1. treasury bills and notes
2. federal agency securities
3. certificates of deposit (CDs)
4. commercial paper
5. banker's acceptance
6. eurodollar certificates of deposit
7. money market funds
What are treasury bills and notes?
Obligations of the federal government.
What is the difference between a treasury bill and a treasury note?
Treasury bills are short-term and treasury notes are short-to-intermediate term.
What are federal agency securities?
Obligations of federal agencies, such as the Federal Home Loan Bank.
What are certificates of deposit (CDs)?
Savings deposits at financial institutions (large CDs have a secondary market).
What is commercial paper?
Unsecured short-term promissory notes issued by large creditworthy corporations.
What is a banker's acceptance?
A draft drawn on a bank for payment when presented to the bank.
Why are banker's acceptances often available at discounted prices as investments?
Because they generally have to be presented from 30 to 90 days after issuance.
What are eurodollar certificates of deposit?
CDs offered by foreign banks to obtain dollars for the eurodollar market.
What are money market funds?
Share in a fund that purchases higher-yielding CDs.
Name the two goals of inventory management.
1. to ensure adequate inventories to sustain operations
2. to minimize inventory costs, including holding costs, ordering and receiving costs, and costs of running out of stock.
What are management's choices with regards to inventory when demand is seasonal?
1. produce at a near uniform level of production all year, or
2. produce at a high level during the season of peak demand.
How should management determine which inventory production method is more cost-effective?
Compare the cost of holding additional inventory under the uniform-level alternative to the additional production costs associated with the seasonal-production alternative.
What tools can management use when inventory is subject to fluctuating prices?
Hedging strategies to reduce the effects of changing prices.
What is the supply chain?
A product's production and distribution processes.
What is supply chain management?
Sharing of information among firms in the supply chain to minimize inventory levels and make the process as efficient as possible.
What is the economic order quantity model?
It is used to determine the inventory order quantity that minimized inventory costs.
How is the optimum inventory reorder point determined?
By balancing inventory holding costs against the stockout costs.
What is materials requirements planning (MRP)?
A computerized system used to manufacture goods based on demand forecasts.
What is the key weakness of MRP?
It is a "push through" system - products are manufactured based on the master schedule whether they are needed or not.
What is the result of inaccurate forecasting in an MRP system?
Inventories may accumulate at various production stages.
What is a just-in-time (JIT) purchasing system?
A demand-pull inventory system which involves the receipt of inventories just before they are needed for productions.
What is required for a JIT purchasing system to be effective?
Suppliers that will deliver timely, defect-free products.
How can JIT be applied to production?
By establishing a system in which each component is completed just before it is needed by the next production stage.
Name six advantages of JIT?
1. lower investments in inventories and storage space
2. lower inventory carrying and handling costs
3. reduced risk of defective and obsolete inventory
4. reduced manufacturing costs
5. reduced number of high-quality suppliers
6. allows the use of backflush costing
What is backflush costing?
Inventory costs are run directly through cost of goods sold.
What is enterprise resource planning (ERP).
Enterprise-wide computerized information systems that connect all functional areas within an organization.
How do ERP systems facilitate supply chain management?
By connecting the firm elctronically to its suppliers and customers.
What is effective receivables management?
Systems for deciding whether or not to grant credit and for monitoring the receivables.
How is the accumulation of receivables measured?
The days' sales outstanding.
What three factors must management consider when deciding whether to change the credit policy?
1. the effect of the change on sales
2. losses from uncollectible accounts
3. accounts receivable holding costs

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