Managing Daily Finances for FMAA™

What is working capital management?

The process of managing cash and current assets and paying liabilities as they come due.

Effective working capital management ensures a company has enough cash to meet its short-term obligations and avoid financial distress.

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Define net working capital.

The difference between current assets and current liabilities.

Net working capital is crucial for bridging the gap between production and cash collection from sales.

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What are the components of net working capital?

Cash and cash equivalents
Other short-term investments
Net accounts receivable
Inventory
Other current assets (e.g., prepaids)
Current liabilities (e.g., accounts payable, current accruals, short-term financing)

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What is the operating cycle?

The amount of time between the acquisition of inventory and the receipt of cash from the sale of the inventory.

It includes the average number of days inventory is held and the average number of days accounts receivable remain outstanding.

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How is the cash cycle calculated?

Days’ Sales in Receivables + Days’ Sales in Inventory − Days’ Payables Outstanding

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What is the difference between the operating cycle and the cash cycle?

The cash cycle accounts for the time between payment for inventory and receipt of cash from sales.
The operating cycle includes the entire process from inventory acquisition to cash collection.

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What is permanent working capital?

The minimum amount of working capital maintained at all times to support day-to-day sales and activities.

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What is temporary working capital?

The increases in working capital that occur from time to time, often due to seasonal business needs.

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What is a conservative working capital policy?

A policy that seeks to minimize liquidity risk by increasing the amount of working capital held, thus increasing the current ratio.

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What is an aggressive working capital policy?

A policy that reduces the amount of working capital and the current ratio, preferring to increase investment in long-term assets for a greater return.

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What is the effect of a transaction that exchanges one current asset for another on net working capital?

No effect on net working capital.

Such transactions merely shift the composition of current assets without changing the total.

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What is the main transaction that increases net working capital?

The sale of inventory.

The receivable created or cash received is greater than the carrying value of the sold inventory, increasing current assets and net working capital.

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What factors influence the amount of cash a company holds?

Near-future cash needs
Risk tolerance regarding liquidity
Level and conversion speed of other short-term assets
Available return on other short-term investments
Position in the operating cycle

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What are the main reasons for a company to hold cash?

As a medium of exchange for business transactions
As a precautionary measure
For speculation

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What determines the level of cash needed by a company?

The speed with which inventory is sold and accounts receivable are collected.

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What is the purpose of a cash flow forecast?

To show the planned sources and uses of cash for the forecast period.

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What are the two key goals of cash flow management?

Collect cash as quickly as possible (cash inflow management).
Delay the payment of cash for as much time as possible (cash outflow management).

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How can a company expedite cash inflows?

Mail or transmit invoices electronically as soon as possible.
Offer discounts for early payment.
Use electronic data interchange (EDI) and electronic funds transfer (EFT).
Accept credit card payments.

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What is the main way for managing cash outflows?

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Make payments as close to deadline requirements as possible, unless taking a cash discount is beneficial.

How can a company control the date when funds are deducted from its bank account?

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Make payments to vendors by electronic funds transfer instead of writing checks.

What are accounts receivable?

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Money owed to a company by its customers for goods or services provided on credit.

Accounts receivable are crucial for maintaining sales in competitive environments where cash payments are not always feasible.

What are the three elements of a company’s credit policy?

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Credit standards
Credit terms
Collection efforts

These elements help determine to whom credit is granted, the terms of sale, and the efforts to collect past due accounts.

What is the impact of relaxing credit standards?

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Increased sales
Higher credit losses
Increased collection costs

Relaxing credit standards allows more customers to qualify for credit, increasing sales but also increasing the risk of defaults.

What is factoring of receivables?

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Selling receivables to a factor to receive immediate cash.

Factoring allows companies to receive cash upfront by transferring the collection responsibility to the factor.

What is the **difference** between factoring with recourse and without recourse?

* **With recourse**: The seller retains the credit loss risk. * **Without recourse**: The factor assumes the credit loss risk. ## Footnote The choice affects the level of risk retained by the selling company.

What is the **accounts payable cycle**?

* Issuing purchase orders * Validating goods received * Receiving vendor invoices * Approving final payments ## Footnote The cycle begins with a request for goods or services and ends with payment to the vendor.

What is **disbursement float**?

The time between when a **check is written** and when the **money is deducted** from the company's account. ## Footnote Disbursement float includes mail float, operational float, and clearing float.

# True or False: A company should slow its cash disbursements to increase the time it has cash in its account.

True ## Footnote Delaying cash disbursements effectively creates an interest-free loan for the period until the funds are deducted from the payer's account.

What is the **main tool** a company can use to **increase disbursement float**?

Make **payments as close to deadline** requirements as possible. ## Footnote Increasing disbursement float allows a company to retain cash longer, effectively creating an interest-free loan.

What does '**2/10, net 30**' mean in payment terms?

A **2% discount** is available if payment is made within **10 days**; otherwise, the **full amount** is due in 30 days. ## Footnote Taking advantage of such discounts can reduce the cost of funds for a company.

How is the cost of not taking a discount **calculated**?

**Cost of not taking the discount** = 365 × Discount % / (Total Period for Payment − Period of Discounted Payment) × (100% − Discount %) ## Footnote This formula approximates the annualized interest rate for the 'interest' charged for paying later.

When should a company take a **cash discount** offered by a supplier?

When the cost of not taking the discount is **higher than the company's cost of capital**. ## Footnote Paying within the discount period is generally advantageous if the cost of not taking the discount exceeds the company's cost of capital.

What are the main reasons for **carrying inventory**?

* To have **goods available for customers** to purchase. * To maintain **flexibility in purchasing** raw materials. * To ensure **production can continue** without delays. ## Footnote Carrying inventory helps meet customer demand and supports uninterrupted production.

What are the types of **inventory costs**?

* Purchasing costs * Carrying costs * Opportunity costs * Ordering costs * Stockout costs ## Footnote Each type of cost impacts the overall profitability and efficiency of inventory management.

What is **safety stock**?

The **amount of inventory** a company plans to have **on hand** when the next shipment is due to arrive. ## Footnote Safety stock helps prevent stockouts and ensures continuous operations.

How is the **reorder point** calculated?

(Average daily usage × Average lead time) + Safety Stock ## Footnote The reorder point indicates when a company needs to place an order for inventory to avoid stockouts.

What is the primary goal of a **Just-in-Time** inventory system? | (JIT)

* Minimize the **level of inventories** held at all stages of production. * Meet **customer demand** in a timely manner with high-quality products at the lowest possible cost.

What is a **key advantage** of using a **JIT** inventory system?

* Reduction in the cost of carrying inventory. * Decrease in the risk of damage, theft, loss, and inability to sell finished goods.

How does a JIT system **differ** from traditional inventory systems?

**JIT** is a 'pull system' that responds only to actual demand, unlike **traditional 'push systems'** that produce based on forecasts.

What is **essential** for a company using JIT purchasing?

* Close relationships with suppliers. * Frequent deliveries of smaller amounts of inventory. * High-quality inventory to avoid defects.

What is **Material Requirements Planning**? | (MRP)

A system for **ordering and scheduling** dependent demand inventories using **computer software**.

What type of **inventory management system** is **MRP** primarily considered?

A '**push-through**' inventory management system.

What **information** does MRP use to determine necessary outputs and order timing?

* Demand forecasts for finished goods. * Bill of materials for each finished product. * Quantities of materials, components, and product inventories.

What **challenge** do management accountants face when using MRP?

The need to **collect and maintain** updated inventory records and estimate setup and downtime costs.

How can MRP **improve profitability and ROI**?

By **reducing the amount of cash** tied up in inventory through careful planning and management.

Managing Daily Finances Flashcards

Understand working capital and the operating cycle, and apply best practices in cash management through effective management of inventory, receivables, and payables. (45 cards)