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301 exam 2 - 301 Exam 2 Chpt 4Working capital management...

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301 Exam 2 Chpt 4- Working capital management- management of short-term assets and liabilities of the firm; day to day activity How much cash and inventory should we keep on hand? What credit terms should we offer to our customers How will we obtain any needed short-term financing If we borrow short-term, how and where should we do it o Net working capital=current assets-current liabilities Cash management- Transaction motive- holding cash or near-cash to make planned payments for items such as materials and wages Safety motive- holding cash to protect the firm from being unable to satisfy unexpected demands for cash Speculative motive- holding cash to be able to quickly take advantage of unexpected opportunities Operating cycle-time a company purchases raw material and provides labor for production to the time it collects payment for its final products Days sales in inventory (DSI)-purchase raw material sell finish goods Days sales outstanding (DSO)-sell finished goods collect accounts receivable Cash conversion cycle- length of time between the payment of cash for inventory (raw materials) and the receipt of cash from accounts; number of days from when you pay supplier and collect from customer CCC=days sales in inventory (DSI)+days sales outstanding (DSO)- Days payable outstanding (DPO) o Days sales in inventory-purchase inventory sale on credit o Days sales outstanding- sale on credit collect accounts receivable Positive cash conversion cycle-requires short term financing to support its cash conversion cycle To decrease positive CCC Increase inventory turnover Lengthen payables period (longer terms) Expedite collections Negative CCC- preferred; company’s average payment period is longer than its operating cycle Manufacturing companies have positive CCC because they have longer operating cycles
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Non-manufacturing firms carry lower inventory and sell products faster=lower CCC Managing current assets- Carrying costs- easy to measure, on income statement; costs of holding inventory; rise with increase in current assets o Capital costs- cost of funds invested o Warehousing-inventory o Insurance-inventory o Bad credit- accounts receivable Shortage costs- tough to measure decrease with increases in current assets o Stock out- run out of inventory o Sales- tight credit limit sales Optimal investment in current assets=minimum point= carry costs=shortage costs Flexible short term financing policy- firm maintains high levels of inventory and grants liberal credit terms to its customers; high level of accounts receivable Cost more but higher future cash flows Restrictive short term- holding low levels of inventory and accounts receivable Less investment in current assets=cost less but may reduce growth Managing current liabilities- Cash reserves- firm with a high level of cash and marketable securities does not require much financing for other current assets it holds
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