Working Capital Components and Calculations
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Questions and Answers

What is the inventory period for Brick Brewing Co.?

  • 136.83 days
  • 35.36 days
  • 101.47 days (correct)
  • 71.33 days

    • How long did it take Brick Brewing Co. to collect on their accounts receivable?

  • 35.36 days (correct)
  • 136.83 days
  • 65 days
  • 101.47 days

    • What is the total operating cycle for Brick Brewing Co.?

  • 42.33 days
  • 101.47 days
  • 136.83 days (correct)
  • 65 days

    • How is the cash conversion cycle for Brick Brewing Co. calculated?

    <p>Operating cycle - Payables period</p> Signup and view all the answers

    What are carrying costs in relation to working capital?

    <p>Costs of maintaining current assets including opportunity cost</p> Signup and view all the answers

    What is the accounts payable period for Brick Brewing Co.?

    <p>71.33 days</p> Signup and view all the answers

    Which of the following statements is correct regarding the cash conversion cycle?

    <p>It increases when accounts payable period increases</p> Signup and view all the answers

    What was the cash conversion cycle for Brick Brewing Co.?

    <p>65 days</p> Signup and view all the answers

    What percentage of sales does Dynamic Mattress collect in the immediate quarter?

    <p>70%</p> Signup and view all the answers

    What is the maximum amount Dynamic Mattress can borrow under its current bank loan arrangement?

    <p>$100 million</p> Signup and view all the answers

    How much of the sales in the fourth quarter of the previous year was collected in the first quarter of 2017?

    <p>$118.01 million</p> Signup and view all the answers

    What is the interest rate applicable to the bank loan that Dynamic Mattress may utilize?

    <p>10%</p> Signup and view all the answers

    How does Dynamic Mattress plan to stretch its payables for short-term financing?

    <p>By delaying payment of bills</p> Signup and view all the answers

    What is the primary approach to developing short-term financial plans according to the information?

    <p>Trial and error</p> Signup and view all the answers

    What percentage of sales is collected in the next quarter by Dynamic Mattress?

    <p>30%</p> Signup and view all the answers

    What might Dynamic Mattress do with its net cash inflows once they turn positive?

    <p>Invest in long-term assets</p> Signup and view all the answers

    What is net working capital?

    <p>Current assets minus current liabilities</p> Signup and view all the answers

    Which of the following items is considered a current liability?

    <p>Bank indebtedness</p> Signup and view all the answers

    How is the operating cycle calculated?

    <p>Inventory period + accounts receivable period</p> Signup and view all the answers

    What does the cash conversion cycle measure?

    <p>Time between purchasing raw materials and collecting cash from sales</p> Signup and view all the answers

    How is the accounts payable period calculated?

    <p>Annual cost of goods sold / 365</p> Signup and view all the answers

    What represents a component of working capital?

    <p>Cash and cash equivalents</p> Signup and view all the answers

    Which formula can be used to calculate the cash conversion cycle?

    <p>Inventory period + accounts receivable period – accounts payable period</p> Signup and view all the answers

    What is the inventory period formula?

    <p>Annual cost of sales / 365</p> Signup and view all the answers

    What is a line of credit?

    <p>An agreement allowing a company to borrow up to an established limit at any time.</p> Signup and view all the answers

    What is typically required by a bank for a commitment fee?

    <p>The fee charged on the unused portion of a line of credit.</p> Signup and view all the answers

    What is a syndicated loan?

    <p>A loan provided by a group of banks combined to meet a large loan request.</p> Signup and view all the answers

    What percentage of finished goods inventories is typically the maximum amount a bank will lend against as security?

    <p>50%</p> Signup and view all the answers

    In accounts receivable financing, what happens if the firm fails to repay the loan?

    <p>The bank collects the pledged accounts receivable from the firm's customers.</p> Signup and view all the answers

    What characterizes commercial paper?

    <p>It is a short-term unsecured note issued by large corporations.</p> Signup and view all the answers

    What is factoring in the context of financing?

    <p>Selling receivables at a discount for immediate cash.</p> Signup and view all the answers

    What is the main indicator of credit risk assessed by banks when lending?

    <p>The firm’s creditworthiness and ability to repay.</p> Signup and view all the answers

    What does a banker’s acceptance represent?

    <p>A short-term unsecured note guaranteed by the bank.</p> Signup and view all the answers

    How is simple interest calculated?

    <p>Annual interest rate multiplied by the amount of loan divided by the number of periods in the year.</p> Signup and view all the answers

    What is the effective annual rate (EAR) formula based on?

    <p>The quoted annual interest rate and the compounding frequency.</p> Signup and view all the answers

    What does a discount interest loan entail?

    <p>The bank deducts interest upfront from the loan amount.</p> Signup and view all the answers

    What is net working capital?

    <p>The total current assets minus total current liabilities.</p> Signup and view all the answers

    How is the cash conversion cycle defined?

    <p>The time between purchasing materials and receiving payment from customers.</p> Signup and view all the answers

    What is the primary starting point for short-term financial planning?

    <p>Forecasting the sources and uses of cash.</p> Signup and view all the answers

    What happens if a company’s cash inflow forecasts are insufficient to cover expenses?

    <p>The company will require short-term financing.</p> Signup and view all the answers

    Study Notes

    Working Capital Components

    • Current assets include cash, accounts receivable, inventories, and prepaid expenses.
    • Current liabilities include bank indebtedness, accounts payable, accrued liabilities, current portions of finance lease obligations and long-term debt.
    • Net working capital is the difference between current assets and current liabilities.
    • The operating cycle is the time from raw materials purchase to cash collection from finished goods sales. It's the sum of the inventory period and the accounts receivable period.
    • The cash conversion cycle is the time between paying for materials and collecting from sales. It's the operating cycle minus the accounts payable period.

    Calculating Cycle Lengths

    • Inventory period = (Annual cost of sales / 365)
    • Accounts receivable period = (Annual sales / 365)
    • Accounts payable period = (Annual cost of goods sold / 365)

    Brick Brewing Example

    • Brick Brewing's 2018 data: Revenue: $50,084,490; Cost of sales: $37,108,956; Inventory: $10,316,767; Accounts receivable: $4,851,774; Accounts payable: $7,303,233.
    • Brick Brewing's inventory period was 101.47 days.
    • Brick Brewing's accounts receivable period was 35.36 days.
    • Brick Brewing's accounts payable period was 71.33 days.
    • Brick Brewing's operating cycle was 136.83 days (101.47 + 35.36).
    • Brick Brewing's cash conversion cycle was 65 days (136.83 - 71.33).

    Working Capital Trade-off

    • Maintaining current assets involves carrying costs, including the opportunity cost of capital.

    Dynamic Mattress Example: Short-Term Financial Planning

    • Dynamic Mattress's 2017 sales forecast (in millions): Q1 - $560; Q2 - $502; Q3 - $742; Q4 - $836.
    • 70% of sales are collected in the current quarter; 30% in the next.
    • Dynamic Mattress uses bank loans (up to $100 million at 10% interest) and stretching payables (up to $100 million per quarter) for short-term financing.

    Short-Term Financing Options

    • Bank loans: Lines of credit (with commitment fees), term loans, and syndicated loans.
    • Secured loans: Loans backed by assets like accounts receivable and inventory. Factoring involves selling receivables at a discount.
    • Commercial paper: Short-term unsecured notes issued by large corporations.
    • Banker's acceptances: Time drafts accepted by a bank, sold to investors.

    Interest Calculations

    • Simple interest: (Loan amount × annual interest rate) / (Number of periods per year)
    • Effective annual rate considers compounding: (1 + (quoted annual interest rate / m))^m - 1, where 'm' is compounding periods per year.
    • Discount interest: Interest deducted upfront; effectively increases the interest rate.

    Long-Term vs. Short-Term Financing

    • Long-term assets are typically financed with equity and long-term debt.
    • Short-term financial planning focuses on managing current assets and liabilities.
    • Short-term financial plans are developed iteratively through trial and error.

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    Related Documents

    Fundamentals of Corporate Finance Chapter 20 PDF

    Description

    This quiz covers the essential components of working capital, including current assets and liabilities, as well as key calculations such as inventory and cash conversion cycles. Through examples like Brick Brewing's 2018 data, you'll deepen your understanding of how to measure and manage working capital efficiently.

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