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FINA 351 – Managerial Finance, Ch. (Assign. 17)
Working Capital Management (continued)
FLOAT AND CASH MANAGEMENT
1.
The famous economist, John Keynes, came up with three reasons why a business might hold cash: transaction, precautionary, and speculative.
(A) Which motive for holding cash relates to holding cash to get bargain sales (e.g. going-out-of-
business sales) at Kmart?
(B) Which motive would be present if you held cash in order to pay for groceries?
(C) Which motive would be present if you held cash for emergencies (e.g. your car sputters and dies)?
(D) According to a recent survey, four-out-of-ten Americans are just one missed paycheck away from defaulting on their financial obligations. Not being able to cope with a sudden disruption in income is very poor working capital management. Similar to households, most organizations also need to sock away a sufficient number of months of operating cash. How many months of operating expenses do experts recommend that the average American family keep in cash-on-hand?
2.
Check kiting occurs due to the float or time between when a check is written and when it clears all the banks. When check kiting occurs, someone incurs losses. For example, suppose you write a check to Roger’s Bakery for a box of donuts, knowing full well you had insufficient funds in your account to cover the check. However, by the time Roger’s deposits your check and it clears your bank (maybe 2-
3 days later), you will have deposited enough money to cover the check. So essentially, you got donuts
(and likely consumed them immediately) without paying for them until two days later. Whose money did you use to buy the donuts?
3.
Float is dying a steady death; it used to be over a week but is now just a few days. Electronic payments
(debit cards, credit cards, and ACH transactions such as autopay) now exceed check payments in the U.S. personal consumer market. Consumer usage is continuing to grow for debit cards, ACH, and credit cards, while check payments are decreasing. Businesses, on the other hand, are a little more reticent to abandon checks, with about half of U.S. businesses still paying by check. However, many businesses plan to convert to electronic payments over the next few years. In contrast, most students today rarely write checks (although your grandparents probably still write checks). Question: Which of the following do you mostly use for your personal transactions: coin/currency, checks, debit cards, credit cards, ACH payments/(autopay), or online payments through a website? CASH MANAGEMENT
4.
T or F: Financial managers seek to maximize collection float and minimize disbursement float.
5.
Regarding collection float:
(A) What are the advantages of having lockbox?
(B) Microsoft reported that it has 350 subsidiaries in 118 countries that use 100 different banks. It was
able to free-up $250 million per day by utilizing a cash concentration system. How does a cash concentration system free-up cash?
6.
Regarding disbursement float:
(A) What is one questionable way to maximize disbursement float?
(B) Most organizations maintain some zero-balance accounts (ZBAs). What is the advantage of a ZBA?
7.
When a business temporarily has excess cash to invest, it usually parks these funds in safe, short-term investments that will at least yield some return. List at least two such investments? CREDIT AND RECEIVABLES
8.
What is one advantage and one disadvantage of making sales on credit?
9.
When granting credit to customers, a business must consider a number of factors in determining the appropriate length of the credit period. Of the following customers, determine which would likely be granted the longer
credit period:
(A) Customer X sells a miracle cure for baldness, while customer Z sells toupees.
(B) Customer S has an inventory turnover of 5 (sells big ticket items, e.g. jewelry or appliances), while customer T has an inventory turnover of 20 (sells small stuff).
(C) Customer M sells fresh fruit, while customer P sells canned fruit.
10.
Businesses often grant cash discounts to encourage customers to pay early. Suppose your business receives an order for 2000 solar-powered flashlights at $50 each. You plan to set the terms as 3/30, net
90.
(A) How many days does your customer have to pay before the account is past due?
(B) When is payment due in order to get the discount?
(C) What is the cost of granting the discount, expressed as an approximate
Effective Annual Rate (EAR)? [Note: the exact
formula for the EAR is (1 + Rate) ^ (365/ Net Credit Period less Cash Discount Period) less 1. For more info, see Example 17.2 in your text or instructor notes. You will not need to use the exact formula on an exam]. (D) Should you offer a cash discount under these terms?
11.
(A) Before granting credit to a business customer, what information about the business might be gathered?
(B) What are the classic five Cs that should first be evaluated before granting credit?
12.
Assume that you apply for a loan from at a bank. Many banks require information on a loan application with points attached to various answers. This allows the bank to create a scoring system to assess your credit risk in a fast and unbiased manner. If the points add up to a certain number, you get the loan. But if they don’t add up, sorry—no loan. At the end of this document is a simplified example of a credit scoring process. Complete the example and record here your number of points and whether you would get credit. Don’t despair if you don’t score well – few full-time students do.
13.
The most common credit-scoring system used today for consumers is generated by Fair Isaac Corporation (ticker FICO), which provides a standardized credit-score for each person with a credit record in the US. Your FICO score and credit record are undoubtedly some of the most important
personal statistics that will influence your life. They affect just about everything, including whether an
apartment landlord will rent to you, whether you qualify for a car loan, whether you get good auto insurance rates, and whether you land that dream job (many prospective employers check your credit record).
FICO scores are what a majority of lenders use to evaluate your creditworthiness. The scores are based on a number of factors that analyze the electronic credit files maintained on virtually all adults in
the U.S. The scores range from the 300 to 850 (the higher the better). Many lenders reserve their most favorable terms for borrowers with FICO scores of 750 and above. Loan applicants below 600 get progressively higher rates and loan fees, if in fact they get a loan at all. The sub-prime mortgage crisis involved sub-prime borrowers with credit scores below 620.
(A) What are at least three consequences of having a poor (sub-prime) FICO score?
(B) What factors are considered in the FICO score (see instructor notes)?
(C) Suppose your FICO score was 620. Is that a good score? How about 825?
14.
Review an actual credit report at the end of this document and answer the following questions: (A) According to the summary at the end of the credit report, how many late payments did this person have?
(B) How many adverse trades did this person have (bankruptcy, collection agency, foreclosure, repossession, etc.)?
(C) What was the average FICO score of the three credit bureaus? (D) How would you rate this person’s credit score: better than average, average, or poor?
15.
(A) What is an aging schedule? How does it help you monitor receivables?
(B) What are the normal steps taken to collect from a delinquent customer?
(C) How much do you think collection agencies typically keep for their commission? (Just take a wild
guess; better yet, see the instructor notes).
INVENTORY MANAGEMENT
NOTE: Although discussed in this chapter, the Economic Order Quantity model is covered in other business
classes, such as Operations Management, so we won’t duplicate it here. However, business students should be familiar with the model and its basic premise of optimizing inventory levels. SIMPLIFIED EXAMPLE OF CREDIT-SCORING QUESTIONNAIRE
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1. What is your age?
1-25 yrs (8 pts)
25-29 yrs (12 pts)
30-34 yrs (10 pts)
35-39 yrs (6 pts)
40-44 yrs (14 pts)
45-49 yrs (18 pts)
50 + yrs (25 pts)
2. How many years have you lived at your current address (school address)?
< 1 yr (-10 pts)
1-2 yrs (-3 pts)
2-3 yrs (0 pts)
3-5 yrs (4 pts)
5-9 yrs (14 pts)
> 9 yrs (26 pts)
3. How many years have you held your current job?
Unemployed (-20 pts)
< 1 yrs (-14 pts)
1-3 yrs (0 pts)
3-6 yrs (5 pts)
6-8 yrs (9 pts)
> 8 yrs (16 pts)
4. Do you own the place where you stay or do you rent?
Own (30 pts)
Rent (-32 pts)
Other (0 pts)
5. What bank accounts do you have?
Checking & Savings (24 pts)
Savings only
(11 pts)
Checking only
(6 pts)
Neither
(-10 pts)
6. Do you have a telephone?
Yes (9 pts)
No (0 pts)
7. How many credit cards (including department store cards) do you have?
None (0 pts)
1 (13 pts)
2-4 (8 pts)
4-6 (3 pts)
>6 (-2 pts)
8. What is you annual gross income?
$0-$10,000
(-7 pts)
$10,000-$15,000
(0 pts)
$15,000-$19,000
(5 pts)
$19,000-$25,000
(8 pts)
$25,000-$35,000
(13 pts)
$35,000-$50,000
(20 pts)
> $50,000
(25 pts)
Scoreboard:
If you accumulate less than 75 points, you would probably not get a loan, as you would be in a group
that has a bad debt ratio of at least 10%. If you score between 75 and 100 points, you would probably get the loan, as your group would have a bad debt ratio of only 5%. If you score more than 100 points, you most certainly would get the loan, as your group would have a bad debt ratio of less than 2%.
CREDIT REPORT EXAMPLE
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