Term
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Definition
| current assets - current liabilities |
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Term
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Definition
| converted to cash, sold, or consumed within the longer of 1 year or the operating cycle |
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Term
| current assets in descending order of liquidity |
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Definition
| cash and equivalents, mkt. securities, receivables, inventories, and prepaid items |
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Term
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Definition
| settled or converted into other liabilities within the longer of 1 year or the operating cycle |
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Term
| current liabilities include |
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Definition
| A/P, N/P, current maturities of long-term debt, unearned revenues, wages payable and other accurals. |
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Term
| permanent working capital |
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Definition
| level of liquid current assets must be maintained to meet the firm's long-term minimum needs regardless of level of activity or profitability |
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Term
| temporary working capital |
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Definition
| As the firm's needs for current assets change on a seasonal basis, temporary working capital is increased and decreased. |
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Term
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Definition
| amount of current liabilities, such as trade payable and accruals, that arises naturally in the ordinary course of business without the firm's financial managers needing to take deliberate action. |
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Term
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Definition
| arises when a company is allowed credit terms by its suppliers. |
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Term
| accrued liabilities (SWIDT) |
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Definition
| salaries, wages, interest, dividends, and taxes payable- are another source of interest-free spontaneous financing. |
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Term
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Definition
| current assets - current liabilities |
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Term
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Definition
| converted to cash, sold, or consumed within the longer of 1 year or the operating cycle |
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Term
| current assets in descending order of liquidity |
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Definition
| cash and equivalents, mkt. securities, receivables, inventories, and prepaid items |
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Term
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Definition
| settled or converted into other liabilities within the longer of 1 year or the operating cycle |
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Term
| current liabilities include |
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Definition
| A/P, N/P, current maturities of long-term debt, unearned revenues, wages payable and other accurals. |
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Term
| permanent working capital |
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Definition
| level of liquid current assets must be maintained to meet the firm's long-term minimum needs regardless of level of activity or profitability |
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Term
| temporary working capital |
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Definition
| As the firm's needs for current assets change on a seasonal basis, temporary working capital is increased and decreased. |
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Term
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Definition
amount of current liabilities, such as trade payable and accruals, that arises naturally in the ordinary course of business without the firm's financial managers needing to take deliberate action.
What cannot be satisfied through spontaneous financing must be funded through careful financial planning. |
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Term
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Definition
| arises when a company is allowed credit terms by its suppliers. |
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Term
| accrued liabilities (SWIDT) |
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Definition
| salaries, wages, interest, dividends, and taxes payable- are another source of interest-free spontaneous financing. |
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Term
| How do accruals relate to the matching principle? |
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Definition
| Accruals have the additional advantage of fluctuating directly with operating activity, satisfying the matching principle. |
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Term
| debt obligations (short- vs. long-term debt) |
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Definition
| Long-term debt = higher interest rate, so more expensive, but lower default risk. |
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Term
| maturity matching/hedging |
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Definition
| ideal approach of matching assets with short-term liabilities; rarely occurs. |
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Term
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Definition
| Minimize liquidity risk and interest rate risk by financing its temporary working capital with mostly long-term debt, but more expensive and working capital sits idle. |
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Term
| What happens to the current ratio as a company becomes more conservative (incurs more long-term debt)? |
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Definition
| As a company becomes more conservative, there is an increase in the ratio of current assets to current liabilities because of greater liquidity. |
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Term
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Definition
Reduces liquidity and accepts a higher risk of short-term cash flow problems in an effort to increase profitability.
Avoids having funds tied up in LTD, but runs the risk of either unexpectedly high interest rates or even the total unavailability of short-term financing. |
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Term
| risk and profitability in relation to financing |
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Definition
temporary WC financed w/STD: medium risk
temporary WC financed w/LTD: low risk
permanent WC financed w/STD: high risk
permanent WC financed w/LTD: medium risk |
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Term
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Definition
| firm's ability to pay current debts as they come due and remain in business in the short-term. Measures the ease with which assets are converted to cash with little to no loss in value. |
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Term
If current ratio is very low...
If current ratio is very high... |
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Definition
liquidity problem.
management may not be investing idle assets properly. |
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Term
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Definition
| (cash and equivalents + mkt. securities + net receivables) / current liabilities |
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Term
| Does collecting a previously written off receivable affect the current ratio and/or the working capital ratio? |
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Definition
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Term
| Keynes' three motives for holding cash (TPS) |
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Definition
transactional motive (medium of exchange)
precautionary motive (cushion for unexpected contingencies)
speculative motive (take advantage of unexpected opportunities) |
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Term
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Definition
| determine and maintain the firm's optimal cash balance |
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Term
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Definition
| only the amount needed to satisfy current obligations as they come due should be kept |
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Term
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Definition
minimum amount that the bank requires the firm to keep in its demand (checking) account.
It is non-interest bearing and represents an opportunity cost as it is unavailable for short-term investment. |
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Term
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Definition
| time between when a payor puts a check in the mail until the funds are available in the payee's bank |
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Term
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Definition
| most important strategy for expediting the receipt of funds. |
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Term
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Definition
| used by firms w/lockbox network. Regional banks that provide lockbox services automatically transfer their daily collections to the firm's principal bank, where they can be used for disbursement and short-term investment. |
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Term
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Definition
| three-party instrument in which one person (the drawer) orders a second person (the drawee) to pay money to a third person (the payee). |
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Term
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Definition
| most common form of draft; can be used to delay outflow of cash by being dated on the due date of an invoice. |
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Term
| payable through draft (PTD)- adv. and disadv. |
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Definition
not payable on demand like a check and the drawee is the payor, not the bank. Allows the firm to maintain lower cash balances.
Vendors prefer checks that are payable on demand and banks impose higher processing charges for PTDs. |
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Term
| zero-balance account (ZBA) |
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Definition
At the end of each processing day, the bank transfers just enough from the firm's master account to cover all checks presented against the ZBA that day.
Allows for higher balances in the master account from which short-term investments can be made. The bank charges a fee for this service. |
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Term
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Definition
| period of time from when the payor puts a check in the mail until the funds are deducted from the payor's account. |
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Term
| Can having too much cash cause problems? |
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Definition
| Yes- too much idle cash. Also, it can raise banks' interest payouts and make them subject to more stringent ratio and reserve requirements. |
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Term
| important aspects of marketable securities |
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Definition
| a place to invest idle cash and earn a modest return with liquidity and safety |
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Term
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Definition
| market for short-term investments where companies invest their temporary surplus of cash. |
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Term
| What is the CFO concerned with when managing cash and short-term investments? |
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Definition
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Term
| U.S. Treasury obligations |
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Definition
safest investment, exempt from state and local taxes and are highly liquid.
State and local governments also issue their own short-term securities exempt from taxation. |
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Term
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Definition
| maturities of 1 yr. or less. Rather than bear interest, they are sold on a discount basis. |
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Term
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Definition
| maturities of 1-10 yrs. Semiannual payments. |
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Term
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Definition
| maturities of 10+ yrs. Semiannual payments. |
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Term
| repurchase agreements (repos) |
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Definition
| means for dealers in govt. securities to finance their portfolios. When a repo is bought, the firm is temporarily purchasing some of the dealer's government securities. The dealer agrees to repurchase them at a later time for a specific (higher) price providing the securities dealer a secured short-term loan. Overnight to a few day maturities. |
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Term
| federal agency securities (2 types) |
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Definition
| 2 types: those backed by faith and credit of U.S. government and those that are backed only by the issuing agency (GSEs) |
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Term
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Definition
| government-sponsored enterprise; backs its own mortgage-backed securities |
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Term
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Definition
| drafts drawn by a nonfinancial firm on deposits at a bank. Must rely on the creditworthiness of the bank. |
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Term
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Definition
| short-term (270 days or less), unsecured N/Ps issued in denominations ($100,000 or more) by large corporations with high credit ratings to other corporations and institutional investors, such as pension funds, banks, and insurance companies. |
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Term
| certificates of deposit (CD) |
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Definition
| form of savings deposit that cannot be withdrawn before maturity without a high penalty. Lower return than commercial paper b/c they are less risky; negotiable CDs are traded under the regulation of the Federal Reserve System. |
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Term
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Definition
| time deposits of U.S. $s in banks located abroad |
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Term
| money-market mutual funds |
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Definition
| invest in short-term, low-risk securities. In addition to paying interest, these funds allow investors to write checks on their balances. |
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Term
| goal of receivables management |
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Definition
| offer the terms of credit that will maximize profits, not sales. |
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Term
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Definition
Maximizing sales alone can lead to cash flow problems.
At the same time, default risk can be minimized by raising credit standards, but this could starve the company of sales.
Proper balance must be struck. |
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Term
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Definition
| arrangement in which an entity sells its A/R, at a discount, to another entity called a factor, that usu. specializes in collections. |
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Term
| accounts receivable turnover ratio |
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Definition
number of times in a year the total balance of receivables is converted to cash
A/R turnover = net credit sales / avg. balances in receivables |
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Term
| average collection period (days' sales in receivables) |
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Definition
measures the average number of days that pass between the time of a sale and receipt of the invoice amount
days' sales in receivables = days in year / A/R turnover ratio |
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Term
| purpose of inventory management ratios |
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Definition
| report the efficiency of inventory management |
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Term
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Definition
number of times per year the total balance of inventory is converted to cash or receivables
inventory turnover = CoGS / avg. inventory
or
inventory turnover = (days' sales in inventory- days in year) / inventory turnover ratio |
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Term
| Since higher inventory turnover is generally better, why is it better? What increases inventory turnover? |
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Definition
Higher rate generally better, implying that excess inventory and obsolete inventory are not carried.
Higher sales w/out increase in inventory balances will result in better turnover.
Reducing inventory levels also increases inventory turnover. |
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Term
| four components of total inventory cost |
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Definition
purchase costs + carrying costs + ordering costs + stockout costs
Minimizing the total cost of inventory involves constant re-evaluation of the trade-offs among these four components. |
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Term
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Definition
| actual invoice amounts charged by suppliers |
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Term
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Definition
| costs of holding inventory, including storage, insurance, security, depreciation, or rent of facilities, interest, obsolescence and spoilage, and the opportunity cost of funds tied up in inventory (% of investment in inventory). |
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Term
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Definition
| fixed costs of placing an order with a vendor, independent of the number of units ordered. For internally manufactured units, these consist of the set-up costs of a production line. |
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Term
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Definition
| stockout costs- opportunity cost of missing customer order; these can also include the costs of expediting a special shipment necessitated by insufficient inventory on hand. |
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Term
| tradeoffs among four costs |
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Definition
Stockout costs can only be minimized by incurring high carrying costs.
Carrying costs can be minimized only be incurring the high fixed costs of placing many small orders.
Ordering costs can be minimized only at the cost of storing large quantities. |
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Term
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Definition
| amount of time expected to pass between placing an order with a supplier and receipt of the goods |
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Term
| just-in-time (JIT) inventory |
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Definition
| When lead time is known and demand is uniform, the goods can be timed to arrive just as inventory on hand is exhausted through binding agreements. |
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Term
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Definition
| inventory buffer held as a hedge against contingencies |
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Term
| How is the appropriate amount of safety/buffer stock determined? |
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Definition
| Determining the appropriate level of safety stock involves a probabilistic calculation that balances the variability of demand with the level of risk the firm is willing to accept of having to incur stockout costs. |
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Term
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Definition
| amount of inventory on hand indicating that a new order should be placed |
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Term
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Definition
| reorder point = (average daily demand * lead time in days) + safety stock |
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Term
| economic order quantity (EOQ) model |
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Definition
| mathematical tool for determining the order quantity that minimizes the sum of ordering and carrying costs. |
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Term
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Definition
EOQ = square root of (2OD / c).
O = ordering cost per purchase order
D = periodic demand in units/usage of units
c = periodic carrying costs per unit |
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Term
| assumptions underlying the EOQ model (DON) |
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Definition
Demand or production is uniform (and periodic demand is known).
Order (setup) costs and carrying costs are constant.
No quantity discounts are allowed. |
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Term
| What happens to each order if demand rises? If ordering costs rise? If carrying costs rise? |
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Definition
If demand rises, each order must contain more units.
If ordering costs rise, each order must contain more units.
If carrying costs rise, each order will contain fewer units. |
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Term
| perpetual inventory system |
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Definition
| every item received is individually recorded in the tracking system. Inventory and CoGS are updated after every sale (intensive bookkeeping). |
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Term
| What entity uses a perpetual inventory system? |
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Definition
| The entity that requires accurate inventory information at all times. |
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Term
| Must a full-inventory count be performed under a perpetual inventory system? Under a periodic system? |
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Definition
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Term
| Is determining the optimal reorder point harder under a periodic or perpetual system? |
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Definition
| Periodic system. The continuous monitoring inherent in perpetual system allows reorder points for all items to be preprogrammed. The use of a perpetual system makes the employment of replenishment models such as EOQ more practical. Added expense of a perpetual inventory system can pay off in terms of the reduced order and carrying costs made possible by modern replenishment techniques. |
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Term
| value-added cost & examples |
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Definition
cost of activity that increases the value of a product or service to the customer
standard costs of DM and DL necessary to produce the product and product-specific features. |
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Term
| What happens when value-added costs are reduced? |
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Definition
| Reduction in value-added costs will decrease the utility derived from the product and will cause the customer to pay less for the product. |
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Term
| non-value-added cost & examples |
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Definition
cost of an activity that does not increase the value of product or service to the customer
costs of moving, handling, and storage of inventory and rework costs of defective products. |
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Term
| What happens when non-value-added costs are reduced? |
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Definition
| Reduction in these costs does not affect the customer's valuation of the product. |
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Term
| examples of costs with value-added and non-value-added components |
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Definition
| indirect labor and indirect materials nontraceable and testing and inspection costs |
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Term
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Definition
| looks at entire production process to identify value-added activities and minimize non-value-added activities |
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Term
| just-in-time (JIT) inventory (continued from card 75) |
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Definition
| Moving, handling, and storage of inventory are treated as non-value-added activities. |
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Term
| pull system (demand-driven) |
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Definition
| In JIT, production of goods does not begin until an order has been received; eliminates FG inventories. |
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Term
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Definition
| minimize the cost associated with inventory control and maintenance by reducing the lag time between inventory arrival and use. |
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Term
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Definition
| JIT environment; eliminates the traditional sequential tracking of costs; entries can be delayed until the end of the period. |
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Term
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Definition
| ticket (cards or markers) controls the flow of production or parts so that they are produced or obtained in the needed amounts at the needed times. |
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Term
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Definition
| A kanban acts as an authorization to release inventory to the next step. |
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Term
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Definition
A basic kanban system includes a withdrawal kanban that states the quantity that a later process should withdraw from its predecessor;
a production kanban stating output of receiving process;
and a vendor kanban that tells a vendor what, how much, where, and when to deliver. |
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Term
| materials requirements planning (MRP) |
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Definition
computer-intensive system for driving raw materials through a production process according to a predetermined schedule
MRP embodies the principle of dependent/derived demand.
Creates schedules and automatically generates POs. |
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Term
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Definition
| MRP environment. Demand for raw materials is driven by forecasted demand for the final goods of which they are a part. |
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Term
| three components of MRP system |
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Definition
| master production schedule, bill of materials, and perpetual inventory records along with true inventory count of every component, subassembly, and FG at all times. |
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Term
| master production schedule |
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Definition
| table of projected demand for end products along with the dates they are needed |
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Term
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Definition
| table of every component part required by every end product (and every subassembly) |
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Term
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Definition
| extends the scope of MRP. While MRP is driven by programmed/forecasted demand, MRP II adds a feedback loop (hence the designation of MRP II as a closed-loop system) to allow a manufacturer to take production considerations into account, along with demand. |
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Term
| operating cycle & formula |
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Definition
amount of time between inventory acquisition and the collection of cash on sale of that inventory
operating cycle = days' sales in receivables + days' sales in inventory |
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Term
| cash conversion cycle & formula |
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Definition
time between outlay of cash for inventory purchases and the collection of cash on sale of that inventory
cash conversion cycle = days' sales in receivables + days' sales in inventory – average payables period, or operating cycle – avg. payables period. |
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Term
| accounts payable (A/P) turnover |
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Definition
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Term
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Definition
| days in year / A/P turnover |
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Term
| operating cycle vs. cash conversion cycle |
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Definition
| Difference between the operating cycle and the cash conversion cycle arises from the fact that the firm's purchases of inventory are made on credit, so the cash conversion cycle = operating cycle – avg. payables period. |
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