Exam 17: The Management of Working Capital

Criteria for extending credit to new customers usually involve the following issues: (1) length of time in business (2) adequate net worth (3) an acceptable current ratio (4) a "clean" credit record.

Explain the economic reasons for holding cash.

Compensating balances cannot normally be used for transactions.

Unlike accruals, the volume of trade payables is controllable by the financial manager.

An expansion of inventory produces cash inflows from additional sales that are partially offset by additional carrying costs.

Under a pledging agreement, the borrower offers its receivables as collateral for a loan.

Financing long-term projects with short term financing is risky because the bank may refuse to renew the short-term loan when it comes due.

More aggressive collection procedures will generally reduce credit sales.

Factoring involves the sale of accounts receivable by the firm that originally generated the receivables.

Excess cash can be invested in marketable securities which earn a modest return but are almost as liquid as cash itself.

Compensating balances refer to charges that compensate the bank for work it does to balance customer accounts.

Marketable securities are liquid investments that can be held instead of cash but do not earn any return.

Transit float in the check clearing system is the time required for checks to clear through the banking system.

Float, or money tied up in the process of check clearing, consists of transit float arising from the administrative functions of the payee that delay the actual deposit of the check and processing float created in the Federal Reserve's check clearing system.

The cash manager's goal is to minimize the firm's cash balances.

Carrying excess cash is convenient but expensive because cash earns little or no return.

Discuss the idea of stretching payables clearly indicating the pros and cons of the idea.

Compensating balances can be stated as a percentage of the loan outstanding under a line of credit.

The administrative reason for holding cash is to pay for emergency needs.

By factoring its receivables, a firm converts them into cash immediately rather than having to wait for customer payment.