FIN 3120 1st Edition Exam #2 Study GuideChapter 16 – • Working capital calculations o Working Capital = total investment in current assets (C/A)o Net Working Capital = C/A – C/L• AFC calculationso Effects of a cash discount on AFC• Profitability = EBIT/Total Assetso Conservative – large proportion of current assets Lower profitability Less risk More LT debt (safer for the borrower)• Less refinancing, less interest risk• Hurts shareholderso Moderate o Aggressive – small proportion of current assets Higher profitability Higher risk More ST debt (safer for the lender)• Will refinance often• Lower interest rates for ST debt, less interest costs/higher profit- Types of Loans:o Short-Term Credit Unsecured vs. secured Cash-flow based vs. Asset based Spontaneous vs. Negotiated Sources:- Trade credit- Accruals/deferred incomeo Interest free financing- Commercial bank loanso Secured or unsecuredo Compensating balances- Stretching accounts payableo Not a long-term solutiono Damages reputation and credit rating Collateral:- Accounts receivableo InventoryThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.o Lines of Credit Good for seasonal needso Revolving Credit “Financing insurance” Legally commits the bank Secured Commitment fee on unused fundso Commercial Paper ST unsecured promissory notes 9 month max (270 days) Not typical investments – no 3rd party guarantor ALWAYS discount securities Interest is normally below the prime rate Minimal secondary marketo A/R Loans Collateral for secured ST borrowing Often subject to fraud Pledging vs. Factoringo Inventory Loans Normally raw materials and/or finished goods only, no WIP 4 valuation factors:- Perishability- Identifiability- Marketability- Price stability Promissory noteChapter 17 –- Cash Managemento Speed up collectionso Slow down payments Payments on time – not early, not late Zero-balance system Drafts- Not payable on demand Synchronizing deposits and check clearings- Risky- Requires accurate estimation of float, dependent on outside factorso Compensating balance(s) = lower limito Holding excess liquid assets has an opportunity costo Inadequate liquid assets carries shortage costs Missing cash discounts Lower credit rating Higher interest rates Insolvency- Cash Budgeto Outflows are directly controllable by the firmo Inflows are partially determined outside the firmo Inflows/Outflows are not synched, requires the use of a cash budget- Liquidity Managemento Ratio of cash & marketable securities to total assetso Larger firms tend to hold lower liquid asset balance ratios- Bank Services- Floato Positive – bank overestimationo Negative – bank underestimation- Lock Box Systemo Uses local banks as collection pointso High feeso Beneficial for less, larger deposits (few big clients) Per-transaction fees- Wire Transfers & Depository Transfer Checkso Wire - funds available immediately, higher costo DTC – slow, low cost- Electronic Funds Transfero Decreases floatChapter 18 – - Accounts Receivableo Trade credit: credit provided to other businesso Consumer credit: credit provided to individualso Credit policy can significantly impact company performanceo Large investments- Credit Policyo Standards Controls quality of accounts Based on credit scoreso Terms Period- Low turnover = longer periods- Affects profitability Cash discount (if any) Seasonal datingo Collection Efforts Aging of accountso 5 C’s of Credit: Character Capacity Capital Collateral Conditions- Inventoryo Raw materialso Work-in-Processo Finished goodso Costs: Ordering costs- $ cost per order Carrying costs- Per unit per period- % of inventory value Stockout/Shortage costs- Lost sales- Rescheduling production- Special orders- Expedited shippingo Control Models ABC Classification- Divides into 3 groups:o A – high $, low %o B – mid $, mid %o C – low $ high % EOQ - Assumes demand and lead times are constant and knowno Eliminates shortage consideration- Ignores seasonal fluctuation- Assumes ordering costs are equal for each order and independent of the# of items ordered- Non-zero lead time (extension of basic model)o If demand may fluctuate Just-In-Time