business finance chapter 15 and 16

cash

current asset

marketable securities

current asset

accounts receivable

current asset

inventory

current asset

prepaid expenses

current asset

short-term debt

current liability

current portion of long-term debt

current liability

accounts payable

current liability

accrued liabilities

current liability

marketable securities

very liquid securities that can be converted to cash quickly at a reasonable price

accounts receivable

money owed to a company by customer for products and services provided by credit

accounts payable

company owes debt to suppliers

inventory

can include raw materials, work in process goods, and finished goods that are ready for sale

working capital management

management of current assets and current liabilities

working capital

refers to current assets, which represent the portion of investment that circulates from one form to another in the ordinary conduct of business

net working capital

difference between the firm's current assets and its current liabilities; can be positive or negative

profitability

relationship between revenues and costs generated by using the firm's assets-both current and fixed-in productive activities.

risk (of insolvency)

probability that a firm will be unable to pay its bills as they come due

insolvent

unable to pay bills as they come due

inventory turnover

measures the activity, or liquidity, of a firm's inventory. Cost of goods sold/inventory

average age of inventory

average number of days' sales in inventory. Average age of inventory = 365/inventory turnover

average collection period

average amount of time needed to collect accounts receivable. Average collection period = accounts receivable/average sales per day

average payment period

average amount of time needed to pay accounts payable. Average payment period = accounts payable/average purchases per day

operating cycle

time from the beginning of the production process to collection of cash from the sale of finished product. Operating cycle = Average age of inventory+average collection period.

cash conversion cycle

length of time required for a company to convert cash invested in its operations to cash received as a result of its operations.

permanent funding requirement

constant investment in operating assets resulting from constant sales over time

seasonal funding requirement

investment in operating assets that varies over time as a result of cyclic sales

aggressive funding strategy

funding strategy which the firm funds its seasonal requirements with short term debt and its permanent requirements with long term debt

conservative funding strategy

funding strategy under which the firm funds both its seasonal and its permanent requirements with long term debt

minimizing cash conversion cycle length

turn over inventory as quickly as possible without stockouts that result in lost sales, collect accounts receivable as quickly as possible without losing sales from high pressure collection techniques, manage mail and processing and clearing time to reduc

investment in inventory

can be seen as the amount of funds tied up with inventory

ABC inventory system

inventory management technique that divides inventory into three groups-A,B,C in descending order of importance and level of monitoring, on the basis of the dollar investment in each

Economic order quantity model (EOQ)

inventory management technique for determining an item's optimal order size, which is the size that minimizes the total of its order costs and carrying costs. The EOQ model is an appropriate model for the management of A and B group items from the ABC sys

order costs

are the fixed clerical costs of placing and receiving an inventory order.

carrying costs

variable costs per unit of holding an item in inventory for a specific period of time

just in time system

inventory management technique that minimizes inventory investment by having materials arrive at exactly the time they are needed for production.

materials requirement planning system (MRP)

inventory management technique that applies EOQ concepts and a computer to compare production needs to available inventory balances and determine when orders should be placed for various items on a product's bill of materials

Manufacturing resource planning II (MRP II)

sophisticated computerized system that integrates data from numerous areas such as finance, accounting, marketing, engineering, and manufacturing and generates production plans as well as numerous financial and management reports

enterprise resource planning (ERP)

is a computrized system that electronically integrates external information about the firm's suppliers and customers with the firms departmental data so that information on all available resources-human and material-can be instantly obtained in a fashion

credit standards

firm's minimum requirements for extending credit to a customer

why would a firm change credit standards?

will do so in an effort to improve its returns and create greater value for its owners.

why is credit management even more complex for international business?

firm is exposed to exchange rate risk. dangers and delays involved in shipping goods long distances and in having to cross at least two international borders.

credit terms

terms of sale for customers who have been extended credit by the firm

cash discount

percentage deduction from the purchase price; available to the credit customer who pays its account within a specified time

cash discount period

number of days after the beginning of the credit period during which the cash discount is available.

credit period

number of days after the beginning of the credit period until full payment of the account is due

credit monitoring

ongoing review of a firm's accounts receivable to determine whether customers are paying according to the stated credit terms.

aging schedule

credit monitoring technique that breaks down accounts receivable into groups on the basis of their time of origin; indicates the percentages of the total accounts receivable balance that have been outstanding for specified periods of time

spontaneous liabilities

financing that arises from the normal course of business; the two major short term sources of such liabilities are accounts payable and accruals

unsecured short term financing

short term financing obtained without pledging specific assets as collateral. Firms should take advantage of these "interest free" sources of unsecured short term financing whenever possible.

major source of unsecured short term financing

accounts payable

accounts payable management

management by the firm of the time that elapses between its purchase of raw materials and its mailing payment to the supplier

cost of giving up a cash discount

is the implied rate of interest paid to delay payment of an account payable for an additional number of days

stretching accounts payable

paying bills as late as possible without damaging the firm's credit rating. reduces the implicit cost of giving up a cash discount

accruals

liabilities for services received for which payment has yet to be made.

short term, self liquidating loan

unsecured short term loan in which the use to which the borrowed money is put provides the mechanism through which the loan is repaid. intended merely to carry the firm through seasonal peaks in financing needs that are due primarily to buildups of invent

how banks lend unsecured, short term funds

single payment notes, lines of credit, revolving credit agreements

prime rate of interest (prime rate)

lowest rate of interest charged by leading banks on business loans to their most important business borrowers. rate will fluctuate with changing supply and demand relationships for short term funds.

fixed rate loan

loan with a rate of interest that is determined at a set increment above prime rate and remains unvarying until maturity

floating rate loan

loan with a rate of interest initially set at an increment above the prime rate and allowed to "float", or vary, above prime as the prime rate varies until maturity

discount loan

loans on which interest is paid in advance by being deducted from the amount borrowed

single payment note

a short term, one time loan made to a borrower who needs funds for a specific purpose for a short period

line of credit

an agreement between a commercial bank and a business specifying the amount of unsecured short term borrowing the bank will make available to the firm over a given period of time.

operating change restrictions

contractual restrictions that a bank may impose on a firm's financial condition or operations as part of a line of credit agreement

compensating balance

required checking account balance equal to a certain percentage of the amount borrowed from a bank under a line of credit or revolving credit agreement

annual cleanup

requirement that for a certain number of days during the year borrowers under a line of credit carry zero loan balance. This is to ensure that money lent under a line of credit agreement is actually being used to finance seasonal needs.

revolving credit agreement

line of credit guaranteed to a borrower by a commercial bank regardless of the scarcity of money

commitment fee

fee that is normally charged on a revolving credit agreement; it often applies to the average unused portion of the borrower's credit line.

commercial paper

form of financing consisting of short term, unsecured promissory notes issued by firms with a high credit standing

secured short term financing

short term financing (loan) that has specific assets pledged as collateral.

percentage advance

percentage of the book value of the collateral that constitutes the principal of a secured loan.

pledge of accounts receivable

use of a firm's accounts receivable as security, or collateral, to obtain a short term loan

factoring accounts receivable

outright sale of accounts receivable at a discount to a factor or other financial institution.

factor

is a financial institution that specializes in purchasing accounts receivable from businesses

nonnotification basis

basis on which a borrower, having pledged an account receivable, continues to collect the account payments without notifying the account customer.

notification basis

basis on which an account customer whose account has been pledged (or factored) is notified to remit payment directly to the lender (or factor).

nonrecourse basis

basis on which accounts receivable are sold to a factor with the understanding that the factor accepts all credit risks on the purchased accounts.

short term loan collateral

accounts receivable and inventory