Working Capital and Financial Statement Analysis Review

Comprehensive practice flashcards covering working capital management, cash models, receivables, inventory, short-term debt, and financial statement ratio analysis.

Net Working Capital

The difference between current assets and current liabilities.

Primary Objective of Working Capital Management

To achieve a balance between risk and return in managing the firm's short-term assets and liabilities.

Conservative (Relaxed) Working Capital Financing Policy

A policy where operations are conducted with a relatively large amount of working capital, resulting in higher current and acid-test ratios and lower illiquidity risk.

Inventory Financing with Long-Term Debt

An example of a conservative working capital policy, where long-term capital is used to finance temporary or fluctuating inventory build-up.

Hedging Approach to Financing

A financing method that involves matching the maturities of debt with specific financing needs (matching asset lifespans with debt maturities).

Profitability and Liquidity Relationship

Profitability varies inversely with liquidity; higher liquidity provides greater safety but yields lower returns.

Conservative Working Capital Policy Indicators

Characterized by higher current ratios and higher acid-test (quick) ratios due to elevated levels of current assets relative to current liabilities.

Cash Conversion Cycle (CCC)

The length of time it takes for initial cash outflows for goods and services to be realized as cash inflows from sales.

Operating Cash Conversion Cycle Calculation

$\text{CCC} = \text{Average Age of Inventory} + \text{Average Age of Receivables} - \text{Average Age of Payables}$.

Three-Variable Cash Conversion Cycle Example

Given payables age of $15$ days, receivables age of $60$ days, and inventory age of $10$ days, the cycle is $10 + 60 - 15 = 55\text{ days}$.

Apple Corporation Cash Conversion Cycle (2008)

Resulted in an operating cash conversion cycle of $75\text{ days}$ based on its credit sales, inventories, payables, purchases, and a $360\text{-day}$ year.

Primary Objective of Cash Management

To invest cash for a return while retaining sufficient liquidity to satisfy future operational and debt needs.

Float

The difference between the bank balance for a firm's account and the cash balance shown on the firm's own books.

Compensating Balance

A minimum percentage of the face amount of a loan that a borrower must keep on deposit in a non-interest-bearing account to compensate the bank for services.

Draft

A working capital disbursement technique that increases payable float and delays cash outflows because it must be presented to the payer for acceptance before payment.

Credit Terms Exceeding Customer Operating Cycle

A situation where a seller grants credit terms longer than the purchaser's operating cycle, effectively financing more than just the purchaser's inventory needs.

Impact of Increased Average Collection Period

Causes sales discounts taken to fall, total investment in accounts receivable to increase, and doubtful accounts to rise.

Direct Cash Budget Exclusions

Projected net income and non-cash depreciation expenses are excluded from the direct cash receipts and disbursements method of preparing a cash budget.

Belle Company Collection Agency Evaluation

Accelerating collections from $10$ to $4$ days on $P1,500,000$ monthly receipts at $8\%$ interest yields a net annual benefit of $P6,000$ after paying $P1,500$ monthly fees.

Cash Flow from Income Before Tax Adjustments

Estimated cash flow is determined by adding non-cash expenses like depreciation ($P20,000$) and bond discount amortization ($P18,000$) back to pre-tax income ($P100,000$), yielding $P138,000$.

Annabelle Corporation Float Elimination Impact

Eliminating $3\text{ days}$ of mail float and $1\text{ day}$ of processing float at $P50,000$ daily collections increases average cash balance by $P200,000$.

Aning Company Lockbox Decision

The lockbox should be rejected because annual costs ($P25,200$) exceed the annual earnings from a $3\text{-day}$ float reduction ($P22,500$) by $P2,700$.

Baumol Cash Management Model

An inventory-based model determining the optimal cash conversion balance ($C^*$) to minimize the sum of transaction costs and opportunity holding costs.

Ben Corporation Optimal Cash Balance

Using $T = P432,000$, $F = P8$, and $i = 5\%$, the optimal cash balance ($C^*$) is $P11,757.55$.

Ben Corporation Average Cash Balance

Under the Baumol Model, the average cash balance is $\frac{C^*}{2} = \frac{P11,757.55}{2} = P5,878.78$.

Convertible Bonds

A long-term hybrid corporate security that is not classified as a short-term marketable security.

Treasurer's Primary Short-Term Investment Focus

Safety of principal and liquidity, rather than aggressive maximization of yields.

Accounts Receivable Management Trade-Off

Balancing the incremental profit from increased credit sales against the costs of holding receivables, collection expenses, and bad debt losses.

Accelerating Receivables Collection

Accomplished by shortening credit terms, offering cash discounts, or utilizing lockboxes, whereas aging receivables is purely a monitoring tool.

Average Collection Period Range

For credit terms of $2/10,\text{ net }30$, the average collection period will normally fall between $10\text{ days}$ and $30\text{ days}$.

Gross Receivables Balance Formulas

Represented by: (1) Average daily sales $\times$ Average age in days, (2) Average daily sales $\times$ Average collection period, or (3) Annual credit sales $\div$ Accounts receivable turnover.

Accelerated Collection Outcomes

Results in higher cash discounts taken, lower accounts receivable balances, and lower bad debts, while reducing the average collection period.

Elaine Corporation Collection Change

Lengthening collection by $10\text{ days}$ on $P90,000$ daily sales increases average receivables by $P900,000$, requiring $P81,000$ minimum cost savings at $9\%$ interest.

Irrelevant Factor in Changing Credit Policy Proposals

The company's historical or current bad debt experience when bad debt rates are projected to remain identical under all proposals.

Che-Che Corporation Receivables Impact

Shortening collection from $50$ to $30$ days, raising cash sales to $30\%$, and decreasing sales by $10\%$ causes a $P2,344,444$ decrease in average accounts receivable.

Che-Che Corporation Turnover Impact

Shortening the collection period from $50\text{ days}$ to $30\text{ days}$ increases accounts receivable turnover by $4.8\text{ times}$ (from $7.2$ to $12.0$).

Donny Traders Accounts Receivable Balance

With daily sales of $P50,000$, $70\%$ paying at day $10$ and $30\%$ at day $30$, average collection period is $16\text{ days}$, yielding an accounts receivable balance of $P800,000$.

Flint Company Credit Card Receivables

With $P5,000$ daily sales and a $20\text{-day}$ collection period from credit card companies, the average accounts receivable balance is $P100,000$.

May Corporation Credit Standards Relaxation Benefit

Yields an expected net annual benefit of $P432,000$ after accounting for incremental contribution margin and carrying costs of new receivables.

Sisa Corporation Credit Standards Easing Benefit

A $25\%$ sales increase with longer collection, $4\%$ bad debts on new sales, and higher collection costs generates a net benefit of $P215,000$.

Primary Objective of Inventory Management

To maintain inventory at a level that best balances operational savings, carrying costs, and inventory control efficiency.

Traditional Inventory Cost Categories

Classified into order costs, carrying costs, and stockout costs (excluding order-filling costs).

Inventory Carrying Costs

Costs associated with holding inventory, including handling costs, storage, insurance, property taxes, obsolescence, and interest on invested capital.

Inventory Ordering Costs

Costs incurred each time an order is placed, including purchasing paperwork, shipping, handling, setups, and quantity discounts lost.

Chikoy Corporation Inventory Turnover Savings

Increasing turnover from $9$ to $12$ times on $P14,400,000$ COGS frees up $P400,000$ of capital, saving $P32,000$ annually at an $8\%$ interest rate.

LIFO Inventory Turnover in Inflation

Results in a higher inventory turnover ratio during inflation because current higher replacement costs are matched to COGS while older lower costs remain in ending inventory.

Effect of Decreased Order Frequency

Ordering less frequently means placing larger order quantities, which increases average inventory and total carrying costs while decreasing total ordering costs.

Justification for Low Inventory Turnover

Firms are willing to maintain a lower inventory turnover ratio when the unit cost of stocking out is exceptionally high.

Economic Order Quantity (EOQ) Objective

To calculate the order size that minimizes the total annual sum of inventory carrying costs and ordering (or setup) costs.

Economic Lot Size (ELS) Model

Also called EPQ, it establishes optimal production run sizes by balancing setup costs and carrying costs, assuming constant demand and instantaneous production.

Safety Stock in Basic EOQ

Safety stock is not an input variable in the mathematical basic EOQ formula, though it affects total average inventory.

Directly Reflected Costs in Basic EOQ

Order costs and unit holding costs are directly reflected, whereas purchase price and lost quantity discounts are omitted unless quantity discount models are used.

Assumptions of Basic EOQ Formula

Assumes constant known demand, uniform usage rate, and constant ordering costs per order, but does not inherently assume constant unit cost across quantity tiers.

Foregone Return on Capital in Inventory

Classified as an opportunity carrying cost in the economic order quantity framework.

Emil Traders Economic Order Quantity

Given annual demand of $24,000$, order cost $P38.40$, and carrying cost $P11.52$, the EOQ is $\sqrt{\frac{2 \times 24,000 \times 38.40}{11.52}} = 400\text{ units}$.

Emil Traders Total Order Costs

At an EOQ of $400$, total orders are $\frac{24,000}{400} = 60$, resulting in total ordering costs of $60 \times P38.40 = P2,304$.

Emil Traders Total Carrying Costs

At an EOQ of $400$, average inventory is $200$, giving total annual carrying costs of $200 \times P11.52 = P2,304$.

EOQ Response to Demand Increase

Since EOQ is proportional to $\sqrt{D}$, a $44\%$ increase in annual demand increases the EOQ by $\sqrt{1.44} - 1 = 20\%$.

Edgar Corporation Reorder Point

With daily usage of $\frac{12,600}{360} = 35\text{ units}$ and lead time of $20\text{ days}$, the reorder point without safety stock is $35 \times 20 = 700\text{ units}$.

Edgar Corporation Safety Stock & ROP

With a maximum lead time of $30\text{ days}$, safety stock is $35 \times (30 - 20) = 350\text{ units}$, and the new reorder point is $700 + 350 = 1,050\text{ units}$.

Annie Corporation Maximum Lead Time

With daily usage of $70\text{ units}$, normal lead time of $30\text{ days}$, and safety stock of $1,050\text{ units}$ ($15\text{ days}$), maximum lead time is $45\text{ days}$ and ROP is $3,150\text{ units}$.

Ram Corporation Average Inventory

Calculated as $\frac{\text{EOQ}}{2} + \text{Safety Stock} = \frac{800}{2} + 200 = 600\text{ units}$.

Apple Baby Corporation Annual Carrying Costs

Total carrying costs equal $P2,300$ based on an average inventory of $2,300\text{ units}$ ($2,000$ cycle stock + $300$ safety stock) and $25\%$ unit holding cost.

Apple Baby Corporation Total Order Cost

With annual demand of $40,000$ ($4 \times 10,000$) and EOQ of $4,000$, there are $10$ orders at $P200$, totaling $P2,000$.

Emy Manufacturing Present Inventory Costs

With lot size $2,250$, setup costs are $15 \times P500 = P7,500$ and carrying costs are $\frac{2,250}{2} \times P15 = P16,875$, totaling $P24,375$.

Emy Manufacturing Economic Lot Size

The optimal lot size is $\sqrt{\frac{2 \times 33,750 \times 500}{15}} = 1,500\text{ units}$.

Emy Manufacturing Optimal Production Runs

Using the EOQ model, the optimal number of production runs is $\frac{33,750}{1,500} = 22.5\text{ runs}$.

Emy Manufacturing Inventory Cost Savings

Total costs at EOQ are $22.5 \times 500 + 750 \times 15 = P22,500$, representing a decrease of $P1,875$ from the previous $P24,375$.

Non-Short-Term Credit Source

Common stock is equity capital, unlike short-term credit sources such as payables, accruals, and deferred income.

Cost of Trade Credit

Trade credit is not costless if cash discounts are foregone, as failing to take discounts imposes a high implicit interest cost.

Secured Short-Term Borrowing Form

Chattel mortgage involves specific personal property pledged as security, making it a secured form of borrowing.

Effective Rate on Discounted Loan

For a $10\%$ stated loan discounted in advance, the effective rate is $\frac{10\%}{1 - 10\%} = 11.11\%$.

Discounted Loan with Compensating Balance Effective Rate

For a $10\%$ interest rate and $20\%$ compensating balance on a discounted loan, the effective rate is $\frac{10\%}{100\% - 10\% - 20\%} = \frac{10\%}{70\%} = 14.29\%$.

Principal Calculation with Discount and Compensating Balance

With proceeds of $P340,000$, $12\%$ interest deducted in advance, and $20\%$ compensating balance, the principal is $\frac{P340,000}{1 - 0.12 - 0.20} = P500,000$.

Cost of Foregoing Trade Discount (350-Day Year)

For terms $3/10,\text{ net }30$, the nominal annual rate is $\frac{3}{97} \times \frac{350}{20} = 54.12\%$, which equates to an annual rate of $55.67\%$.

Treasury Bill Price on Discount Basis

A $P100,000$ bill due in $180\text{ days}$ at an $8\%$ discount basis is priced at $100,000 - (100,000 \times 0.08 \times \frac{180}{360}) = P96,000$.

Trade Credit vs Bank Loan Decision (Jun Traders)

Borrowing from the bank at $12\%$ is cheaper than foregoing terms of $2/10,\text{ net }30$ ($36.73\%$) by $24.73\%$.

Borrowing to Maintain Minimum Current Ratio

With current assets $P625,000$ and liabilities $P250,000$, a firm can borrow up to $P125,000$ in short-term debt before the ratio falls below $2.0$.

Effective Rate with Interest-Earning Compensating Balance

Net interest paid divided by net usable funds yields an effective rate of $10.89\%$ for a $P500,000$ loan with existing deposit credits.

Cost of Pledging Receivables (Baby Apple)

Borrowing at $10\%$ interest on $80\%$ loan value results in an annual financing cost of $10\%$.

Cost of Commercial Paper (Baby Apple)

Issuing $P515,000$ paper every $3\text{ months}$ to net $P500,000$ costs $\frac{15,000}{500,000} \times 4 = 12\%$ annually.

Cost of Compensating Balance Bank Loan (Baby Apple)

Borrowing at $5\%$ with a $15\%$ compensating balance yields an annual rate of $\frac{5\%}{80\%} = 6.25\%$.

Lei Company Factoring Net Proceeds

The monthly net proceeds advanced on $P500,000$ receivables factored at an $80\%$ advance rate after deducted charges is $P383,333$.

Lei Company Factoring Net Cost & Effective Rate

Generates an annual net cost of factoring of $P100,000$ and an effective annual financing rate of $26.09\%$.

Factoring Effective Rate without Advance Deduction

When charges are paid at maturity rather than deducted in advance, the effective annual cost rate drops to $25\%$.

Loi Factoring Net Proceeds

Factoring $P500,000$ receivables due in $60\text{ days}$ with a $10\%$ reserve, $2\%$ commission, and $12\%$ annual interest yields $P431,200$ net proceeds.

Jem Traders Discount Payment Amount

Taking a $2\%$ discount on a $P100,000$ invoice requires $P98,000$ to pay within the discount period.

Jem Traders Bank Loan Principal

To net $P98,000$ with a $30\text{-day}$ loan at $12\%$ discounted interest ($1\%$ monthly) and a $10\%$ compensating balance, the principal is $\frac{98,000}{1 - 0.01 - 0.10} = P110,112$.

Jem Traders Effective Loan Rate

The annualized effective interest rate for the $30\text{-day}$ bank loan is $13.48\%$.

Annual Cost of Non-Free Trade Credit (2/10, net 30)

Calculated as $\frac{2}{98} \times \frac{360}{20} = 36.73\%$.

Horizontal Analysis

A technique for evaluating a series of financial statement data over a period of time to determine the amount and/or percentage increase or decrease.

Base Year in Horizontal Analysis

The earliest year in a comparative analysis series against which subsequent financial statement line items are expressed as a percentage.

Horizontal Analysis with Zero Base Period

When an item has a zero balance in the base year and a positive balance in the current year, it is expressed as an absolute change with no percentage value.

Trend Percentages

A form of horizontal analysis tracking percentage changes in financial statement items across multiple successive accounting periods.

Percentage Increase to Offset a Prior Decline

If net income falls from $Php200,000$ to $Php50,000$, it must increase by $\frac{200,000 - 50,000}{50,000} = 300\%$ to return to its original level.

Vertical Analysis

An evaluation of financial statement items expressing each component as a percentage of a total base amount within the same statement.

Common-Size Financial Statements

Statements where dollar figures are converted to percentages, enabling comparison of component mixes across time or between firms of differing sizes.

Common-Size Balance Sheet Base

Total assets (or total liabilities and shareholders' equity) represents $100\%$.

Data Omitted by Common-Size Statements

Common-size balance sheets reveal percentage distributions and capital structure but do not show the absolute currency (peso) amounts.

Core Ratio Analysis Categories

The standard evaluation dimensions are liquidity, leverage (solvency), and profitability (marketability is an investment attribute).