Flashcards

F1 pt2

P H Inglês 199 flashcards

Flashcards do conjunto (199)

1What is key to IFRS5 (non-current assets held for sale and discontinued operations)?*Objective is to establish principles of reporting information for discontinued operations and non-current assets held for sale (F1 focuses on held for sale)
2What is key to non-current assets held for sale?*Disposal of asset when asset sold (removed from records and a gain/ loss on the sale is recorded)
*At date when FSs prepared, possible parts of the business/ separate assets may not have been physically disposed of but obvious they're no longer to be used - can then be classified as non-current asset held for sale
*Entity classes classifies it if its carrying amount would be recovered principally through a sale transaction rather than through continuing use
*NB not depreciated!
3What is the criteria for non-current assets held for sale?1) available for immediate sale in its present condition and;
2) sale is highly probable
A sale is highly probable if conditions met:
1) management committed to sell asset
2) active programme to locate buyer initiated
3) asset actively marketed at a reasonable price
4) sale expected to complete within one year from date of classification
5) it is unlikely plan will change/ be withdrawn
4What are the two implications to the financial statements of the classification of an asset held for sale?1) Measurement - value at lower of the carrying amount or fair value less costs of disposal (e.g. selling costs)
2) Classification - prior to classification as held for sale, asset treated in line with applicable standards e.g. depreciated as normal until classification is changed. Classification of asset as non-current asset held for sale means it will not be depreciated
*NB if value of asset held for sale less than carrying amount on SOFP, should be written down and impairment charged against profit
5How are assets held for sale presented and what disclosures are there?*Classified as a separate category of current asset
6What needs to be considered if there are any assets valued under revaluation model that meet criteria of an asset held for sale?*First revalue as normal then separately write down to fair value less costs to sell
*Costs to sell recognised as an immediate impairment cost in the SOPL
*Revaluation surplus transferred upon disposal to retained earnings
7What is key to IFRS 16 (Leases)?*Entity may need particular asset for operations but not have cash available to purchase outright so could lease to use the asset on day-to-day basis via periodic rental payments
*A common method of financing
8What is the definitions of a lease, lessor, lesee and right of use asset?1) LEASE - 'a contract, or part of a contract, that conveys the right to use and asset (the underlying asset) for a period of time in exchange for consideration'
2) LESSOR - 'an entity that provides right to use and underlying asset for a period of time in exchange for consideration'
3) LESSEE - 'entity that obtains the right to use and underlying asset for a period of time in exchange for consideration'
4) Right-of-use asset - 'an asset that represents a lessee's right to use and underlying asset for the lease term'
9What is key to lessee accounting?*Leessee will make payments to the lessor
*At commencement of lease, lessee should recognise:
1) lease liability
2) right-of-use asset
*Accounting treatment will consider the initial measurement and then subsequent treatment of a lease
10What is key to initial measurement of a lease in terms of lease liability?*Lease liability initially measure at present value of the lease payments that have not yet been paid (discount rate should be the rate implicit in the lease, but if cannot be determined, entity should use its incremental borrowing rate (ie. rate to borrow funds to purchase similar asset)
Includes:
1) fixed payments over lease term
2) variable lease payments dependent on index or rate (initially measured using index/ rate as commencement date)
3- Amounts expected to be payable under residual value guarantees
4) Exercise price of a purchase option if the lessee is reasonably certain to exercise that option
5) payments of penalties for terminating lease (if lease term reflects the lessee exercising an option to terminate lease)
11What is meant by a residual value guarantee?*Provided by lessee and states underling asset at end of lease term will not be worth less than a specified amount (reduces risk of damage and unauthorised use of the asset)
12What is key to lessee accounting in terms of right-of-use asset (in IFRS 16)?*Right-of-use asset initially recognised at cost
*Initial cost of right-to-use asset includes:
1) amount of initial measurement of lease liability (previous list)
2) Lease payments made at or before commencement date
3) Any initial direct costs
4) Estimated costs of removing/ dismantling underlying asset as per conditions of the lease
13What is key to initial measurement of a lease in terms of lease liability?What is meant by a lease term?*Length of time that lessee has right-of-use of an asset
*To calculate initial value of liability/ right-to-use asset, lessee must consider length of lease term
*Lease term comprises
1) non-cancellable periods
2) periods covered by an option to extend the lease (if reasonably certain to be exercised)
3) periods covered by an option to terminate the lease (if these reasonable certain not to be exercised)
14What is key to subsequent measurement of a lease in terms of lease liability?*Carrying amount of lease liability increase by interest charge
*Interest recoded in SOPL
DR: finance costs (SOPL)
CR: Lease liability (SOPL)
*Carrying amount of the lease liability reduced by cash payments:
DR: lease liability
CR: cash
*NB layout of lease table will depend on whether payments made at end of the year (in arrears) or start of year (in advance)
(SEE LEASE LIABILITY TABLES)
*NB for payments in advance, current liability element in table is balance carried forwards - subtotal. Non-current liability element is the subtotal
15What is key to subsequent measurement of a lease in terms of right-of-use asset?*Right-of-use asset measured using a cost model - measured at initial cost less accumulated depreciation and impairment losses
*Depreciation calculated as:
1) if ownership of asset transfers to lessee at end of lease term, depreciation charged over asset's remaining useful life
2) otherwise, depreciation charged over shorter of useful life and lease term
16What other measurement models does IFRS 16 allow?*Those varying from cost model to be applied to right-of-use asset (eg. fair value methods or revaluation methods may be applied)
*Applicable if right-of-use relates to an asset normally accounted for using these methods/ models - e.g.
1) investment properties valued at fair value (right-of-use asset can be revalued to fair value, gains or losses to P&L)
2) items of PPE using a policy of revaluation. Right-of-use asset may be revalued with gains or losses to revaluation reserves
17What is key to short life and low value assets in IFRS 16 (leases)?*If lease term short (less than 12 months at inception) or of low value, simplified treatment is allowed
*in these cases lessee can chose to recognise lease payments in P&L on straight-line basis (no lease liability or right-of-use asset recognised)
*NB no specific monetary value given for a low value asset, but IFRS16 gives following examples:
1) tablets/ small personal computers
2) phones
3) small items of furniture
*Assessment of whether asset qualifies as having a 'low value' must be made based on value when new (car would not qualify even if very old at commencement date of lease)
18What is key to IAS 2 inventories?Inventories are assets that are:
1) held for sale in the ordinary course of business
2) in the process of production
3) materials that will be used in the production process
*Measured at the lower value of cost and net realisable value
19How are inventories measured?At the lower value of:
1) Cost
- cost of purchase, costs of conversion and costs to bring inventory to present location and condition
- costs of conversion may include production overheads (these should be allowed based on normal production levels)
2) Net Realisable Value - estimated selling prices less costs to completion less costs to sell
20What costs are not included in inventory?1) Abnormal amounts of wasted materials, labour or other production costs
2) storage costs
3) administration costs that do not contribute to bringing the inventories to their present location and condition
4) selling and distribution costs
(THESE COSTS TO BE TREATED AS EXPENSES - against profit in the period they arise)
21How can costs be determined?1) Costs of purchase - include purchase price, import duties, handling costs and other costs directly connected to acquisition of goods
2) Costs of conversion - include costs directly related to the units being produced (e.g. direct labour costs/ allocation of fixed and variable overhead costs incurred in production)
3) Variable production overheads - those indirect costs of production that vary directly with the volume produced (e.g. light/ heat/ power)
4) Fixed production overheads - those indirect costs of production that do not vary with the volume produced and remain constant regardless of the number of units produced (e.g. depreciation of machinery, factory administration costs)
22How are overheads allocated?*The allocation of fixed production overheads should be based on the normal capacity of the business
*Any excess overheads due to inefficiencies or production problems should be treated as an expense in the period they occur
23How are costs (in terms of inventory) calculated?*If inventory should be value at cost (when cost is lower than net realisable value) either at actual costs of an item (unit cost) or reasonable approximation to actual cost should be used
*A reasonable approximation would be used if the determination of an item's actual cost is impractical (e.g. there are a large number of items in a particular line of inventory or it is impossible to identify actual costs)
24What are the most common approximations of cost?1) FIFO (first in, first out) - closing inventory is assumed to consist of latest purchases (e.g. oldest inventory sold first - means closing inventory valued at most recent purchase prices) - appropriate for inventory lines (e.g. food on supermarket shelves)
2) AVCO (average cost) - weighted average cost calculated by taking total purchase price of all units purchased in the period divided by total number of units purchased in period - can be calculated using periodic or continuous method. Most appropriate for inventory stored together where cost prices would fluctuate and would be impossible to distinguish before different cost lines
25What are the disclosure requirements of IAS 2 inventories?1) Accounting policy adopted including cost formula used
2) Total carrying amount (raw materials + WIP + finished goods)
*This would be disclosed in a note to the statements (total amount of closing inventory shown as current asset on the SOFP and a reduction to the cost of sales in the SOPL
3) Amount of inventories carried at NRV
4) Amount of inventories recognised as expense during period
5) Details of circumstances that have led to write-down of inventories to their NRV
26What is key to IAS 10 - Events after the Reporting Period?*Purpose of IAS10 to define what extent events that occur after the reporting period should be recognised in the financial statements
*Defines an event after the end of the reporting period as 'those events, favourable and unfavourable, that occur between the end of the reporting period and the date when the financial statements are authorised for use'
27What two types of events after the reporting period are identified in IAS10?1) ADJUSTING EVENTS - those events which provide evidence of conditions that existed at the reporting date (FS should be adjusted to reflect the adjusting event)
2) NON-ADJUSTING EVENTS - those that are indicative of conditions that arose after the reporting date (FS should not be adjusted to reflect). Non-adjusting events should be disclosed if they affect user understanding of the FS
28What are examples of adjusting events?*EVENTS THAT GIVE EVIDENCE OF CONDITIONS THAT EXISTED AT THE REPORTING DATE*
1) selling inventory post year-end for lower than cost price (evidence that inventory is incorrectly valued at year-end)
2) Evidence that customer has gone into liquidation
3) discovery of fraud or error that existed prior to year-end
4) completion of an insurance claim relating to an event that occurred prior to year end
5) determination after year end of the sale or purchase price of assets sold or purchased before year end
29What are examples of non-adjusting events?*NON-ADJUSTING EVENTS SHOW CONDITIONS THAT HAVE ARISEN SINCE THE REPORTING DATE*
1) Acquisition or disposal of a subsidiary after year end
2) Announcements of a plan to discontinue an operation
3) Destruction of an asset by fire/ flood after reporting date
4) Announcements of a plan to restructure
5) share capital transactions after the reporting date
6) Changes in taxation or exchange rates after the reporting date
7) Strikes or other labour debates
8) Equity dividends declared after the reporting period but before the FS are authorised for issue
30What is key to going concern?*If event after the reporting date indicates entity no longer a going concern the FS for the current period should not be prepared on going concern basis
*If not going to be a going concern then the accounts would be prepared using the 'break up' basis where all assets valued at lower of cost and NRV and all liabilities reclassified as current
31What is key to disclosures for IAS 10?*A non-adjusting event after the reporting date should be disclosed (via note) where the event has a material effect on the FS
Note to disclose:
1) Nature of event
2) An estimate of the financial effect or a statement that is not practicable to make such an estimate - estimate should be made before taking account of taxation with an explanation of the taxation implications where necessary for a proper understanding of the financial position
3) Date the directors approve FS - the date on which FS are authorised for issue should be disclosed
32What is the importance of statements of cash flows?1) Helps users to assess liquidity and solvency - an adequate cash position is essential in the short term both to ensure survival of business and enable debt/ dividends to be paid
2) Helps users to assess financial adaptability - will entity be able to take effective action to alter cash flows in response to to any expected events?
3) Helps to assess future cash flows - adequate cash position in longer term is essential to enable asset replacement, repayment of debt and to fund further expansion. Users will use current cash flow information to help them assess future cash flows
4) Helps to highlight where cash being generated - cash flow statement will clearly detail cash that is being generated from core activities of business and other non-operating activities
5) Cash flows objective - cash flow matter of fact whereas calculation of profit is subjective
6) Can help to indicate problems early on
33What are key definitions in IAS 7 'Statement of Cash Flows'?CASH - cash comprises cash on hand and on demand deposits (important that cash includes bank overdrafts)
CASH EQUIVALENTS - short term highly liquid investments that are readily convertible to known amount of cash and which are subject to an insignificant risk of changes in value (e.g. short dated treasury bill)
OPERATING ACTIVITIES - principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities
INVESTING ACTIVITIES - are the acquisition and disposal of long term assets and other investments not included in cash equivalents
FINANCING ACTIVITIES - activities that result in changes in the size and composition of the contributed equity and borrowings of the entity
34What is included in the cash flow statement?SEE PROFORMA
Includes
*Cash flows from operating activities
*Cash flows from investing activities
*Cash flows from financing activities
35What is key to cash flows from operating activities?*Can be broken down into:
1) cash generated from operations - can be calculated through 1) direct method and 2) indirect method
2) Cash paid
3) Interest paid
36What is key to the indirect method for calculating cash generated from operations?*This method involves reconciliation from profit before tax to cash generated from operations
*SEE CALCULATION*
Calculation starts with profit before tax from SOPL adjusting it for non-cash items and covering income and expenses figure from accruals basis to the cash basis so cash flows generated from operating activities remain
37What adjustments need to be considered using the indirect method for calculating cash generated from operations?1) Depreciation/ amortisation
2) Profit/loss on disposal
3) Interest receivable/ investment income
4) Finance costs
5) Change in receivables
6) Change in inventory
7) Change in payables
38What is key to depreciation/ amortisation and profit/loss on disposal as adjustments needing to be considered using the indirect method for calculating cash generated from operations?DEPRECIATION/ AMORTISATION - depreciation not a cash flow. Capital expenditure purchases/ disposals will be recorded under 'investing activities' at time of cash outflow/ inflow. Depreciation writing off of the capital expenditure over its useful life and simply an 'accounting entry'. Should be added back to profit because it was a non-cash expense deducted from the profit
PROFIT/ LOSS ON DISPOSAL: when non-current asset disposed of: 1) cash inflow from sale (the proceeds) is recorded under 'investing activities' 2) a profit/loss on disposal calculated by comparing carrying amount and proceeds which is recorded in SOPL. Does not = cash flow and should be removed from reconciliation for cash generated from operations. 3) loss on disposal added back as it is non-cash expense deducted from profit. 4) Profit on disposal should be deducted because it is a non-cash reduction to expenses added to profit
39What is key to interest receivable/investment income and finance costs as adjustments needing to be considered using the indirect method for calculating cash generated from operations?INTEREST RECEIVABLE/ INVESTMENT INCOME
*Interest received and investment income not considered part of the day-to-day operations and will be adjusted within the reconciliation for cash generated from operations
*Amount from SOPL should be deducted from profit because its not necessarily the amount that has been received (SOPL prepared on accruals basis)
FINANCE COSTS
*Not considered part of day-to-day operations and will be adjusted within reconciliation for cash generated from operations
*Expense from SOPL should be added to profit because it is not necessarily the amount that has been paid
40What is key to change in recievables/ change in inventory and change in payables as adjustments needing to be considered using the indirect method for calculating cash generated from operations?CHANGE IN RECEIVABLES
*An increase in receivables is a reduction to cash (the more the customers owe, the less cash in the bank)
*A decrease in receivable is an increase to cash
CHANGE IN INVENTORY
*An increase in inventory is a reduction to cash (the more inventory we buy, the less cash in the bank) and decrease in inventory is increase to cash
CHANGE IN PAYABLES
*An increase in payables is an increase to cash (the more the suppliers owed the more cash in the bank) and a decrease in payables is a reduction in cash
41What is key to the direct method for calculating cash generated from operations?*Simply involves adding cash inflows and deducting cash outflows in respect of operating activities
SEE PRO RATA
42What is key to the comparison of direct and indirect method for calculating cash generated from operations?*IAS 7 encourages but does not require use of the DIRECT method*
INDIRECT METHOD:
*reconciliation highlights the fact that profit and cash are not equal
*does not show significant elements of trading cash flows
*Low cost in preparing information
DIRECT METHOD:
*Discloses information not shown elsewhere in the financial statements
*Shows cash flows from trading
*Gives users more information in estimating future cash flows
43What other cash flows are considered form operating activities?1) Interest paid
2) Income tax paid -not tested in F1
SEE PRO FORMA FOR CASH FLOWS FOR INTEREST PAYABLE
44What cash flows are there from investing activities?Cash inflows from investing activities include:
1) interest received
2) dividends received
3) proceeds from sale of non-current assets
Cash outflows from investing activities may include:
1) purchases of non-current assets
*cash flow for interest and dividends received should be calculated using PRO FOMA (see diagram)
45What is key to paid to acquire non-current assets in the statement of cash flows?USE PRO FORMA - non-current assets- carrying amount
46What is key to cash received on disposal of non-current assets in the statement of cash flows?*The proceeds on disposal of a non-current asset may need to be calculated - proceeds can be determined by using profit or loss on disposal
SEE PRO FORMA - non-current assets disposal account
47What is key to cash flows from financing activities?*Cash inflows from financing activities may include:
1) proceeds from issue of shares
2) proceeds from issue of loans/ debentures
*Cash outflows from financing activities may include:
1) repayments of loans/ debentures
2) dividends paid
48What is key to proceeds from new share issues in the statement of cash flows?*Proceeds from share issues will be calculated by looking at the movement on the share capital and share premium accounts extracted from the SOFP
SEE PRO FORMA - share capital and share premium
49What is key to proceeds/ repayments from loan and debentures in the statement of cash flows?*The proceeds/ repayment of loans/ debentures will be calculated by looking at the movement on the loan/ debenture accounts extracted from the SOFP
SEE PROFOMA - loans and PRO FORMA - retained earnings (for dividend paid)
NB - dividend payment can either be found in the SOCIE or by looking at the movement on the retained earnings account
50What are the types of short-term financing?*Current liabilities should not be allowed to increase to a level where cash position and liquidity of the company are at risk - requires careful management of short term finance*
1) Trade payables
2) Factoring or invoice discounting of trade receivables
3) Bank overdrafts and short term loans
4) Financing exports
51What is key to trade payables?*Taking advantage of credit terms offered by suppliers allows entities a source of short term finance by paying on credit
*Paying on credit allows entity to 'fund' its inventory through suppliers - to maximise this benefit, should aim to pay as late as possible without damaging trading relationship
*If cash discount offered need to weigh the savings with the additional cost of borrowing to finance funds early
52What are the benefits and potential problems of paying suppliers later than credit terms?BENEFITS:
*Alleviates cash flow difficulties
*Cash can earn a return whilst in entity's account
*trade credit has no interest cost (unlike banks, trade suppliers don't charge interest on debts unless payment is after due date)
POSSIBLE PROBLEMS:
*loss of any settlement discount
*could obtain poor credit rating
*supplier may stop further supplies
*supplier may increase future selling prices to compensate
*could face legal action from supplier
53How can receivables be used as a source of short term finance?1) Factoring
2) Invoice discounting
54What is key to factoring?*Debts of entity sold to factoring company (normally owned by bank). Factor may take responsibility to collect the debt for a fee
*Factor offers three services
1) DEBT COLLECTION - credit control function. Outsourcing credit control department to the factoring entity
2) FINANCING - funds may be advanced to company prior to the debt being collected
3) CREDIT INSURANCE - factor may take responsibility of irrecoverable debt. Factor would dictate whom the entity was able to offer credit (AKA 'without recourse' factoring)
NB - factor often more successful at enforcing credit terms (leading to lower levels of debts outstanding). Factoring therefore not a source of short term finance but also an external means of controlling or reducing levels of receivables
55What is key to invoice discounting?*A service provided by factoring entity
*Selected invoices used as security against which entity may borrow funds
*Temporary source of finance, repayable when debt cleared
*Key advantage is it is confidential and customer need not know about it
*Key financing tool for new businesses (such as management buyouts (MBOs)) - creditworthiness of customers probably higher than their own and invoice discounting utilised to borrow funds
56What is key financial institutions?*A financial institution is an entity with core focus of dealing with financial and monetary transactions
*Transactions can be wide ranging and complex (e.g. deposits/ loans/ investments/ currency exchange)
*Encompass broad range of business operations within financial services sectors including all forms of banks (central/ retail/ commercial/ internet/ investment), trust companies, insurance companies, brokerage firms, investment dealers
*Retail/ commercial banks (and internet banks) provide short term finance to entities - other institutions typically in longer term finance
57What is key to short term borrowing?*Short term cash requirements can be funded by borrowing from banks
1) BANK OVERDRAFT - short term, flexible financing linked to company bank accounts in deficit. Mainly provided by clearing banks and important source of finance for entity
2) BANK LOANS - contractual agreement for specific sum, loaned for fixed period at an agreed rate of interest. Less flexible than overdrafts and can be more expensive but provide greater security
58What are the advantages and disadvantages to bank overdrafts?ADVANTAGES:
1) Flexibility
2) Only pay interest on the balance owed, so generally cheaper
DISADVANTAGES:
1) Repayable to demand
2) May require security
3) Variable finance costs
59What is key to financing exports?*Entities exporting goods to other countries often have greater problems with credit/ finance than entities in domestic markets
*Methods available for dealing with problem of financing exports and controlling credit risk:
1) Documentary credits
2) Bills of exchange
3) Expert factoring
4) Forfaiting
60What is key to documentary credits (irrevocable letters of credit)?*Trading between other countries can be complex, particularly when it takes considerable time to ship goods to exporters country to importer
*Exporter may want payment ASAP but importer needs satisfaction exporter has complied with terms of sale agreement before paying
*Letter of credit is undertaking given by issuer that payment will be guaranteed to exporter provided complies with certain specific requirements within specified time limit
*A document, issued by bank on behalf of customer, authorising person to draw money to specified amount for its branches or correspondents, usually in another country, when conditions met
61What is key to a bill of exchange?*Used primarily in international trade and binds one party to pay a fixed sum of money to another party on demand or at predetermined date (similar to post-dated cheques)
*e.g. supplier of goods (drawer) can draw a bill of exchange on a customer (the drawee). Customer, by signing bill of exchange acknowledges the debt exists and commits to paying it
*Drawer can sell an accepted time draft to a 3rd party (discounting) to receive the cash earlier that in would if it waited for for bill of exchange to mature
*Drawer could also transfer bill to one of its own suppliers in settlement of its own debt (effectively transfers customer debt to a 3rd party)
*NB drawer and payee often same person
62What are the two types of bill of exchange?1) a sight draft/ bill - which is payable immediately
2) a time/ draft bill - which is payable at a predetermined future date (AKA term bills)
63What is a significant characteristic of bills of exchange?1) The drawee is given a period of credit before having pay a term bill
2) the drawer or payee can obtain payment earlier than the bill's maturity date by means of discounting the bill
NB when a bill is discounted it is sold in the financial markets at a discount to face value. Size of the discount reflects the rate of interest that the buyer of the bill requires from holding the bill to maturity
*Bills of exchange AKA 'acceptance credit'
64What is key to export factoring?*Similar to ordinary factoring with exception that the factoring organisation agrees to factor the client's export trade receivables (overseas trading)
*Factor's services include administration of receivables ledger and collecting payment and providing factor finance
*Export factor bus the seller's overseas receivables for a lump sum (often lower than the outstanding debt owed)
*In view of the problems that can arise with collecting payments from customers in other countries, expertise of an export factor can be v. helpful particularly for small/ medium sized businesses with little experience in collecting foreign payments
65What is key to forfaiting?*The same as export factoring except the seller (exporter) will receive 100% of the receivable as a lump sum from the forfaiter
*Exporter will draw a bill of exchange from an importer (the buyer) which is purchased by a fortaiting company (e.g. bank) without recourse to exporter
*Exporter receives total amount owed with the fortaiter chasing the debated importer then settles direct with forfaiter (no risk to exporter
KEY FEATURES:
1) importer obtains medium-term finance for much of the purchase cost of the goods
2) Exporter receives immediate payment
3) Credit risk is accepted by forfaiting bank although this risk is reduced by the guarantee of the promissory notes (AKA bill of exchange)
66What is key to short term investments?*A business might have surplus cash over a period of time - usually it is temporary and only available for a few weeks/ months
*Eventually used to pay suppliers/ settle other liabilities, invest in non-current assets or pay a dividend
*Money in operational bank accounts earns no income (no interest on day to day business accounts at banks)
*Use the cash to earn some return when it is temporary surplus
67What can cash surpluses be used as short term interest earning investments?1) Interest bearing bank accounts
2) Negotiable instruments
3) Short-dated government bonds
4) Other short-term investments
68What is key to consider when looking to temporarily invest cash surpluses?**Consider any FUTURE COMMITMENTS first - is the cash surplus really a surplus - proper planning of forecasts can help to show what can be investments**
1) Maturity
2) Return
3) Risk
4) Liquidity
5) Diversification
69What is key to maturity when looking to temporarily invest cash surpluses?*Receiving interest and the payment of a principal amount at a specific future date termed the 'maturity'
*If investment cashed in or sold before maturity, there could be risk of some loss of the market value or some loss of interest
*Maturity of short-term investment should ideally be no longer than the duration of the cash surplus
*If cash needed before the investment reaches maturity, the investment will have to be 'cashed in' early, with some risk of loss of capital value or interest
70What is key to return when looking to temporarily invest cash surpluses?*With short-term investments, return is the interest yield on the investment
*Some investments offer a higher yield than others
*If the investment is 'redeemable' (i.e. where capital amount will be repaid to the investor) then the capital repayment will also form part of the return
71What is key to risk when looking to temporarily invest cash surpluses?*Some investments more risky than others
*Risk is possibility that investment may fall in value or may be some doubt about eventual payment of interest or repayment of investment principal
*As general rule, higher risk investments often offer higher return to attract investors (risk of less rated bank etc)
*Investing in equities (shares) is high risk - value depends on profitability and future prospects of a company and the share/ stock market
*As share prices can fall by large amount quite quickly, equities generally regarded not suitable for short term investment
*Short term investments should usually be preferred to longer-dated investments because risk of a fall in market value is less
*Prudent entities should avoid high risk investments
72What is key to liquidity when looking to temporarily invest cash surpluses?*Liquidity refers to ease of 'cashing in' investment quickly, without significant loss of value or interest
*All short term investments are less liquid than cash in an operational bank account but some more liquid than others
*e.g. investing in art could be profitable long term but very illiquid as short term investments - cannot be sold quickly without significant risk of selling lower than market value
73What is key to diversification when looking to temporarily invest cash surpluses?*General rule investors should not 'put all their eggs in one basket'
*Diversify by investing in a range of different investments to avoid being exposed to significant losses if investments in one area performing badly
*Less essential for investing short term cash surpluses than for investing in long term equities and bonds
74What is key to interest-bearing accounts?Can be either:
1) bank deposit accounts
2) Money market deposits
75What is key to bank deposit accounts (as form of interest-bearing account)?*Some deposit accounts are 'instant access' which allow investor to withdraw money without notice and without loss of interest
*Interest rate usually low and used when investor wants to earn some interest on surplus cash but places great importance of liquidity
*Some deposit accounts/ savings accounts allow investor to withdraw funds without notice but investor will suffer loss of interest (e.g. if withdrawal notice is 7 days, could withdraw funds without notice but with penalty of 7 days lost interest)
*Some cases investor might be able to withdraw funds from account without giving a minimum notice period
76What is key to money market deposits (as form of interest-bearing amount)?*Amounts of money deposited through a bank in money markets (financial markets for short term borrowing/ lending)
*Money markets largely used by banks/ other financial institutions for depositing/ lending funds (e.g. inter-bank market)
*Interest yields in the inter-bank market often reasonably attractive and now common for entities with large temporary cash surpluses to arrange with their bank to have their money deposited in money markets or at money market interest rates
*Money invested in a money market deposit cannot be withdrawn until deposit matures - can be very short (a day) or as long as several months up to a year
*Very short term deposits should be large amounts of money so the interest earned justifies effort of making the deposit
77What is key to interest earned?SEE CALCULATION
(amount deposited x annualised interest rate) x (number of days interest earned/ annual day count)
NB - annual day count is number of days in the year for interest calculation purposes (365 or 366 days if leap year). Some financial markets set number of days- £ assumes 365 days, US$ assumes 360 days
78What is key to negotiable instruments?*Negotiable instruments are financial instruments that may be obtained as investments
*Key feature is that title passes when instrument handed from one person to another
*They are the 'bearer instruments' and ownership does n't need to be recorded in a register of owners
*Can easily be sold by one entity/ person to another
E.G:
1) Bank notes
2) Bearer bonds
3) Certificate of deposit
4) Bills of exchange
5) Treasury bills
*For short term investments use 3,4,5 as the most important negotiable instruments
79What is meant by a certificate of deposit (CD)?*A negotiable instrument that provides evidence of a short term deposit with a bank for a fixed term and earning specified amount of interest
*Maturity of deposit is usually 90 days or less but can be longer
*Amount deposited is at least $100,000 (or eqv. in other currencies)
*Holder of CD at maturity has right to take deposit with interest
*CD holder presents CD at maturity to recognised bank which with then present the instrument to the bank holding the deposit and arrange for the withdrawal of the deposit with interest
*Until maturity, money 'locked up' with bank can cannot be withdrawn
*When business has temp. cash surplus might arrange its bank to place money in fixed term deposit account for bank to issue CD
80What would be stated on a Certificate of Deposit?1) Identity of the bank
2) Amount deposited
3) Maturity date of the deposit
4) Interest that will accumulate
*Organisation can hold CD until maturity then claim the money
*If org. needs cash before deposit matures, it can sell the CD in an active secondary market of CDs (via bank)
81What is key to investment yield on Certificate of Deposits?*Since CDs are negotiable instruments, more attractive investments than money market deposits from point of view of liquidity
*CD holder can sell the CD to obtain funds quickly whereas money market deposit cannot be withdrawn until maturity
*Yields on CDs are therefore slightly lower than interest yields on money market deposits
82What is key to Bills of Exchange as a negotiable instrument?*Not restricted to export finance arrangements
*Significance of bills of exchange as short term investment is that they are negotiable instruments
*There is active money market for bills of exchange (the discount market) and investors can buy bills
*Market particularly active in BOE that are payable by top quality banks (in UK sometimes called 'eligible bank bills')
*Buyer of BOE obtains right to receive payment by issuer of bill when it matures
*BOE usually an undertaking to pay fixed sum of money at maturity with no interest
*Investor in bill buy bill at discount to face value (and hence right to receive the payment). BOE are therefore e.gs of discount paper
*Possible to buy BOE that have been accepted by a bank and payable by the bank (if bank has high credit status, risk of investing bills is very low)
*Yields on bills vary according to credit risk associated with the bill and investor will be prepared to pay more for top-quality bank bill than for trade bill with much higher credit risk
83What is key to treasury bills as a negotiable instrument?*Negotiable instruments issued by government with maturity less than one year (in practice, most have maturity of three months (91 days))
*Used by a government to finance short term cash requirements in countries like US/UK
*Issued at regular intervals when investors are invited to apply to buy bills in the new issue
*Debts of the government they have high credit quality, low risk and yields for investors lower than for many other short term investments
*Bills issued by government and denominated in the domestic currency should be risk-free
*Bills redeemable at face value so investors pay less than face value to buy them and like BOE, treasury bills are an e.g. of a discount paper
*There is large active secondary market in Treasury Bills in US and UK as are attractive short term investments due to risk free nature and their liquidity
84What is key to short-dated government bonds?*Entites can invest temporary surplus cash in government bonds. If they do:
1) they will receive interest on the due payment dates
2) they can liquidate their investment at any time by selling the bonds in the secondary market
3) if the bonds are short dated when purchased they can hold the bonds to maturity and have them redeemed at par
*However, some price risk with bonds particularly in longer dated bonds. If interest rates change in the market, market value of bonds will rise or fall
*Bond prices rise when interest rate falls but prices fall when interest rate increases - movement in price is greater for longer dated bonds
85What are other key short term investments?e.g.
1) Corporate bonds - bonds issued by an entity. Long term so unsuitable for investing a short term cash surplus and can be high risk. Bond price fluctuates with movements in the general level of interest rates. Also affected by perceived credit risk of the entity issuing the bonds
2) Commercial paper - short dated negotiable debt instruments issued by an entity and sold by a bank managing the entity's commercial paper programme. In practice, although CP negotiable, it is generally purchased by large investment institutions and held the maturity. Not normally regarded as suitable type of short-term investment of cash surpluses by a trading entity
NB theses are more likely to be purchased by investment institutions rather than by entities with short term cash surplus
86What is key to working capital?*The capital available for conducting day to day operations of organisation (normally of excess of current assets over current liabilities)*
*Working capital management is the management of all aspects of both current assets/ liabilities to minimise risk of insolvency while maximising return on assets
*Investing in working capital has a cost which can expressed as:
1) cost of funding it
2) the opportunity cost of lost investment opportunities because cash is tied up and unavailable for other uses
87What is working capital?Difference between:
1) CURRENT ASSETS
- inventory receivables
- cash and bank
- requires funding, therefore consider reducing levels
2) CURRENT LIABILITIES
- payables
- bank
- overdraft
- provide funding, therefore consider increasing levels
88What are the objectives of working capital management?*Main objective of working capital management to get balance of current assets and current liabilities right
*Balancing LIQUIDITY (ensuring current assets are sufficiently liquid to minimise risk of insolvency) and PROFITABILITY (maximising return on capital employed (ROCE) hence minimising investment in working capital)
*Can also be seen as trade off between cash flow versus profits
*Current assets major item on SOFP and especially significant to smaller firms - poor management of working capital a common cause of business failure
89What are consequences of poor working capital managements?1) Inability to meet bills as they fall due
2) Demands on cash during periods of growth being too great (overtrading)
3) Over-Stocking or stock-outs
(Trade-off between liquidity and profitability and its role in determining a business overall investment in working capital is fundamental to understanding of working capital management)
90What is the key to profitability versus liquidity?*Level of overall investment in working capital is a cost/benefit trade off (liquidity vs profitability or cash flow vs profits)
91What is key to cash flow versus profit?*Cash flow as important as profit
*Unprofitable entities can survive if they have cash
*Unprofitable entities can fail if they run out of cash to pay liabilities (wages, amounts due to suppliers, overdraft interest etc)
EG OF TRANSACTIONS WITH TRADE OFF BETWEEN CASH FLOWS AND PROFITS:
1) purchase of non-current assets for cash (cash paid in full to supplier when asset delivered however profits reduced over life of asset as result of depreciation charged)
2) Sale of goods on credit - profits credited in full once sale been confirmed, however cash may not be received for some considerable period afterwards
3) Some payments (e.g. tax) may have significant timing difference between impact on reported profit and cash flow
(cash balances and cash flows need to be monitored just as closely as trading profits)
92What is key to profitability versus liquidity?*Liquidity in context of working capital management means having enough cash (or ready access to cash) to meet all payment obligations when they fall due
*Main sources of liquidity
1) cash in the bank
2) short term investments that can be cashed easily and quickly
3) cash inflows from normal trading operations (cash sales and payments by receivables for credit sales)
4) an overdraft facility or other ready source of extra borrowing
NB basis of the trade-offs is where an entity able to improve its profitability but at the expense of typing up cash
EG:
*receiving bulk purchase discount (improved profitability) for buying more inventory than currently required (reduced liquidity)
OR
*offering credit to customers (attracts more customers so improves profitability but reduces liquidity)
93What are the elements of the working capital cycle?*Length of time between entity's outlay on raw materials, wages and other expenditures and inflow of cash from the sales of goods
INVENTORY DAYS + TRADE RECEIVABLE DAYS - TRADE PAYABLES DAYS = WORKING CAPITAL CYCLE
*Commonly known as cash operating cycle
*Faser a firm can 'push' items around the cycle, the lower its investment in working capital will be
94What is the working capital cycle?cash --> raw materials --> WIP --> finished goods --> receivables
payment of supplier --> payables
ALSO SEE TIME LINE
95What is the working capital cycle key points?*Reflects a firm's investment in working capital as it moves through the production process towards sales
*Investment in working capital gradually increases, first being only in raw materials but then in labour and overheads as production progresses
*This investment must be maintained throughout the production process, the holding period for finished goods and up to final collection of cash from trade receivables
NB net investment can be reduced by taking trade credit from suppliers
96What are the factors affecting length of the working capital cycle?1) Liquidity versus profitability decisions
2) Management efficiency
3) Industry norms e.g. retail versus construction
*Optimum level of working capital is the amount that results in no idle cash or unused inventory but does not put a strain on liquid resources
97What is key to the length of the working capital cycle?*Depends on how balancing act between liquidity and profitability is resolved, the efficiency of management and nature of industry
*Try to shorten cash cycle may have determined effects elsewhere (with org. lacking cash to meet its commitments and losing sales since customers prefer to buy from suppliers who are prepared to extend trade credit and who have items available when required)
*Additionally, any assessment of acceptability or otherwise of the length of cycle must take into account the nature of the business involved
98What are examples of length of cycles?1) a supermarket chain will have very low/ negative cycle has very few, if any, credit customers - high inventory turnover and can negotiate quite long credit periods with suppliers
2) construction entity has long cycles as its projects tend to be long-term often extending over more than a year whilst progress payments may be made by the customer (if there is one), the bulk of cash will be received towards end of the project
99What happens when the amount of cash required to fund the working capital cycle will increase?*Amount of cash required to fund working capital cycle will increase as either:
1) cycle gets longer
2) level of activity/ sales increases
*SUMMED UP AS*
1) if activity/ sales stay contact, length of cycle increases and funds needed increase proportionate days in cycle
2) if activity/ sales increase, length of cycle stays constant and funds needs increase proportionate to sales
NB it may be a key target for management to reduce the operating cycle to improve the efficiency of the business
100What factors affect the amount of working capital required?1) Industry within which entity operates - some industries will have longer payment periods (impacting receivables e.g manufacturing to attract customers - high WIP too), others cash payments may be norm (low receivables - e.g. retail company and has high inventories)
2) Types of products sold - perishable products have lower level of inventory
3) Whether products manufactured or built in - manufacturing company has high levels of raw materials and WIP inventory as well as finished goods
4) level of sales - if sales high, likely receivables high too
5) Policies towards working capital management - different approaches/ strategies
101What is key to woking capital investment levels?*It's essential that appropriate amount of working capital is budgeted to meet anticipated future needs
*In conditions of uncertainty, entities must hold some minimal level of cash and inventories based on expected revenue plus an additional safety barrier
102What facts affect level of working capital investment?1) Nature of business - manufacturing entities need more inventory than service entities
2) Uncertainty in supplier deliveries - uncertainty would mean extra inventory carried in order to cover fluctuations
3) Overall level of activity of the business - as output increases, receivables inventory etc. tend to increase
4) Entity's credit policy - tighter the policy, the lower the level of receivables
5) Length of working capital cycle (longer it takes to convert material into finished goods into cash, greater investment in working capital)
6) Credit policy of suppliers - less credit the entity allowed to take, the lower the level of payables and the higher the net investment in working capital
103What are the possible policies to manage working capital?1) AGGRESSIVE POLICY - attempts to reduce costs by holding lowest levels cash, inventory and receivables as possible. This produces a short operating cycle. This policy carries greatest risk illiquidity as well as generating greatest returns
2) CONSERVATIVE POLICY - attempts to reduct risks by holding high levels of cash, inventory and receivables. Produces long operating cycle. Risks such as stock-outs or liquidity problems are low, but resultantly costs are increased
3) MODERATE POLICY - adopts middle ground between aggressive and conservative approaches
104What are the benefits to an aggressive approach to working capital management?1) Lower levels of current assets therefore lower financing costs
2) Lower financing costs should result in better profitability
3) Quicker cash turnover may allow more reinvestment and hence allow business to expand more quickly
105What are the benefits to an conservative approach to working capital management?1) Lower liquidity risk i.e. less risk of company running out of cash/ going into liquidation
2) Greater ability to meet a sudden surge in sales demand
3) More relaxed credit policy for receivables may improve sales
NB - generally more conservative the approach, the lower the risk but high cost in terms of money tied up in working capital
106What is key to a traditional approach to working capital funding?*level of investment in working capital will depend on policy adopted by management (aggressive/ conservative or moderate) but will depend on other factors (e.g. seasonality)
*Level of investment for working capital will fluctuate over time
*Whatever level of working capital entity requires needs to be financed by long or short term finance (short term generally cheaper as interest rates generally lower)
107How can investment required for working capital be split?1) PERMENANT - i.e. base level of working capital required during the year
2) FLUCTUATING - i.e. portion above the base level required for an entity will be typically governed by entity's approach to managing level of working capital
NB base level required by entity will typically be governed by entity's approach to managing level of working capital (i.e. aggressive approach = lower base level)
108Why is short term finance generally cheaper when considering working capital funding?*Short term interest generally lower than long term rates
*This is an increased risk to the borrower as:
1) RENEWAL PROBLEMS - short term finance may need to be continually renegotiated as various facilities expire and renewal may not be guaranteed
2) STABILITY OF INTEREST RATES - if company constantly changing having to renew funding arrangements will be at mercy of fluctuations in short term interest rates
109In traditional approaches to working capital, how will the degree to which short term finance used depend on entity's attitude to risk?*In reality, an entity will use mix of long and short term finance
*This will depend on entity's attitude to risk, but follows pattern:
1) If aggressive approach to managing working capital, all of the fluctuating and some permanent invested financed short term
2) If conservative, typically all permanent and some fluctuating investment in working capital financed with long term. Short term finance only used for part of fluctuating
3) If moderate approach, typically fluctuating investment will be financed with short term finance and permanent investment with long term finance
110What is key to overtrading?*Healthy trading growth typically leads to:
1) increased profitability
2) need to increase investment in non-current assets and working capital
*If business does not have access to sufficient capital to fund the increase, it is 'overtrading' - can be in serous trouble if unable to pay business payables
111What are typical indicators of overtrading?1) Rapid increase in turnover
2) Rapid increase in volume of current assets
3) Most of the increase in assets funded by credit
4) Dramatic drop in liquidity ratios
112What are potential solutions to overtrading?*Can be serious risk, especially if bank looked to withdraw overdraft facility*
1) raise more long term capital (new shares or loans)
2) slow growth to reduce increase in working capital requirements until sufficient cash built to finance it
3) improve working capital management so there is a reduction in the inventory holding period or a reduction in average time for customers to pay
113What is key to the working capital ratios?*Periods used to determine working capital cycle calculated by series of working capital ratios
*Ratios for 1) inventory 2) receivables, 3) payables and normally expressed as number of days/weeks/months of the relevant SOPL figure they represnet
*Working capital cycle is time span between incurring production costs and receiving cash returns - says nothing about the working capital itself needed over the period..!
114How can the working capital cycle be calculated?SEE PRO FORMA (for manufacturing)
Raw materials at holding period LESS payables payment period, WIP holding period, finished goods holding period and receivable's collection period
*NB ratios sometimes referred to as 1) raw materials days, 2) payable days, 3) WIP days, 4) finished goods days and 5) receivables days
*NB for wholesale/ retail business, no raw materials or WIP holding cycles
*Cycle could be measured in days/ weeks/ months
115What is the raw material inventory holding period?*Length of time raw materials are held between purchase and being used in production*
(Average raw material inventory held/ material usage) x 365
OR
(((opening inventory + closing inventory)/ 2)/ material usage) x 365
NB when usage cannot be calculated, purchases give a good approximation
116What is the WIP holding period?*Average length of time goods spend in production*
(Average WIP/ production cost) x 365
NB where production cost cannot be calculated, cost of goods sold gives good approximation
117What is the finished goods in inventory holding period?*Length of time finished goods are held between purchase/ completion and sale
(average finished goods inventory held/ cost of goods sold) x 365
NB for all inventory period ratios, a low ratio is usually seen as sign of good working capital management - it is expensive to hold inventory so minimum inventory holding usually points to good practice
118What is key to inventory turnover?For each inventory ratio, the corresponding turnover ratio can be calculated
inventory turnover (number of times) = cost of goods sold/ average inventory held
NB generally this is less useful, but gives number of times inventory turned over in a year
119How are inventory periods interpreted?*If inventory days are high, may indicated deliberately conservative policy of holding large amounts of inventory (e.g. management worried about running out of inventory or stockpiling for new launch) - but could result in finance tied up in inventory (especially if sold on credit terms and payment is slow - leaves temporary negative cash flow where inventory being financed by company)
*If inventory too low, may risk running out or indicate company meeting cash flow crisis and running down inventory - could be considered management adopting overly aggressive working capital financing policy
120Why do inventory days need to be compared to other companies/ previous years?*Increasing inventory days may be investigated further by separately analysing raw materials, WIP and finished goods to cost of goods sold
*An increase in raw material days may indicated mismanagement of buying department
*Increase in WIP may indicate production delays
*If finished goods days increase may be sign of decline in demand for product and an increase in obsolete terms
**inventory levels are a balancing act between risk of stock-outs and cost associated with high inventory levels*
121What is key to trade receivables days?*Length of time credit extended to customers*
(average receivables/ credit sales)* 365
- generally a shorter credit period seen as financially prudent but length will also depend on nature of business
122How can trade receivables collection periods be interpreted?*Businesses which sell goods on credit terms specify a credit period
*Failure to send out invoices on time or follow up late payments has adverse effect on cash flow
*Recievables collection period measures average period of credit allowed to customers
*Shorter the collection period better (generally) where receivables effectively 'borrowing' from entity
*Level of receivables reflects not only on ability of the credit controllers, but also sales and marketing strategy adopted/ nature of the business. Any change in level of receivables must therefore be assessed in light of level of sales
123What is key to trade payables days?*Average period of credit extended by suppliers*
(average payables/ credit purchases) x 365
124What complications may there be in payables days ratio calculations?*Differences in way ratio may be calculated:
1) total purchases for year should be used where possible - if not, use cost of sales in the year instead
2) Figure for purchases excludes any sales tax recoverable whereas carrying amount for payables includes tax. To be like-for-like, could add recoverable sales tax back to purchases, or remove sales tax element from trade payables (not usually done though)
3) Where available, average trade payables during year should be used - normally calculated as average of the trade payables at beginning and end of the year. If wish to compare average payment period and recent year to previous year you may need to use end of year trade payables thrasher than average value for year
125What can be useful in comparing payables day ratio with receivables days?*Entity does not normally what to offer customers more time to pay than it gets from its own suppliers (could effect cash flow)
*Generally, longer the payables payment period the better as entity holds cash for longer, but don't want to upset suppliers by dealing payment (could loose discounts/ reliability)
*Incresing payables days suggests advantage taken of available credit but risks include:
1) loosing supplier goodwill
2) losing prompt payment discounts
3) suppliers increasing price to compensate
*NB need to recognise when using ratios that trend of ratios important rather than given figure as payment periods in some entities longer than others
126What is key to working capital cycle?*When summing the ratio 'days' it gives a total length of working capital cycle which indicates entity takes XX days between paying for material purchases and receiving cash back from customers
*Must then be compared to prior periods/ industry average for meaningful analysis
127What key points are worth considering for calculating ratios?*Can be used to calculate working capital cycles
*Useful for providing analysis of the entity's performance
1) where period required in days, multiply ratios by 365, for months use 12, for weeks use 52
2) If required to compare ratios between two SOFP, acceptable to base each holding period on closing figures in SOFP each year rather than average to see whether ratio has increased or decreased
3) For each ratio, the corresponding turnover figure can be calculated by inverting the ratio given and removing the multiplier
4) When using ratios to appraise performance, compare figure with others in the industry or identity the trend over a number of periods
128Why does care need to be taken with ratios?RATIOS HAVE LIMITATIONS..!
1) SOFP values at a particular time may not be typical
2) balances used for a seasonal business may not represent average levels
3) ratios can be subject to window dressing/ manipulation
4) ratios concern past (historic) not the future
5) figures may be distorted by inflation and/or rapid growth
129How can the working capital cycle be shortened?1) Reduce raw material inventory holding - review slow moving lines/ reader levels & quantities. Consider inventory control models. Consider efficiency of links with suppliers (JIT). Reducing inventory may involve loss of discounts for bulk purchases/ cost savings for price rises or could lead to production delays due to inventory shortages
2) Obtain more finance from suppliers by delaying payments - could loose discounts/ reputation though
3) Reduce WIP - improve production techniques/ efficiency
4) Reduce finished goods inventory - could reorganise production schedule/ distribution methods (but could fustrate customers/ loose sales)
5) Reduce credit given to customer by invoicing/ following up on outstanding amounts faster (may loose revenue through discounts/ customers through pushy!)
6) Debt factoring - immediate cash flow generated by selling receivables to 3rd party (may be costly to pay a factor)
130What is meant by 'the balancing act' in accounts receivable?*When businesses sell to customers, they would like the cash to earn profits and stay liquid
*In certain industries there's an expectation of payment on credit (if don't customers go elsewhere). In a credit sale, receivable is created which sits as an asset in the SOFP
*Selling on credit mean business has to wait for cash - to manage liquidity properly management then must create a credit policy to outline T&Cs and internal procedures for offering credit
*Optimum level of trade credit needs to balance:
1) profit investment from sales obtained by allowing credit
2) cost of credit allowed
(LIQUIDITY VS PROFITABILITY trade off - ket in determining working capital investment)
131Why is it important to have a credit policy?*Ideally firm would want cash with each order delivered but it is impossible without substantial settlement (cash) discounts to be offered as an inducement
*Must be recognised that credit terms are part of a marketing policy
*A lenient credit policy may attract additional customers, but may come at a disproportionate increase in cash
1) collecting sales receipts ASAP to reduce cost of financing receivables balance (LIQUIDITY)
VS
2) Extending credit period to customers to encourage additional sales (PROFITABILITY)
132What are examples of different payment terms/ methods?*Payment terms to consider period of credit granted and how payment to be made
*Terms agreed need to specify price, date of delivery, payment date(s) and any discount allowed for early settlement
E.g:
1) pay within 30 days (specified period)
2) 2% discount to pay within 10 days, otherwise 30 day to pay (discount)
3) Weekly credit (to pay on specified day)
4) Cash on delivery (related to delivery of goods)
*Customers can pay with accepted forms:
1) cash
2) BACS (Bankers Automated Clearing Service)
3) Cheque
4) Banker's draft
5) Standing order
6) Direct debit
7) Credit card
8) Debit card
9) CHAPS (Clearing House Automated Payment System)
133What would a credit policy be influenced by for Accounts Receivable?1) Demand for products
2) Competitor's terms
3) Risk of irrecoverable debts
4) Financing costs
5) Costs of credit control
134What are the 4 elements of receivables management?1) Assessing creditworthiness of customers
2) Setting credit limits
3) Invoicing promptly and collecting overdue debts
4) Monitoring the credit system
135How can a firm assess creditworthiness?Assess creditworthiness of:
1) all new customers immediately, before offering credit terms
2) existing customers periodically
Information may come from:
1) bank references
2) trade references
3) visit to customer premises
4) competitors
5) published information
6) credit reference agencies
7) legal sources of credit information
8) entity's own sales records
9) credit scoring
10) credit rating (larger corporate customers)
136How can bank references, trade references and visits to customer premises and competitors to help to assess creditworthiness?1) Bank references - customer permission must be sought. Tend to be standardised in UK so not as helpful as could be
2) Trade references - suppliers already giving credit to customers, although customer may nominate those suppliers where they are paying on time..!
3) Visit to customer premises - sales representative may look at physical operations and assets of customer to reassure that the business has substance
4) Competitors - e.g. in some industries like insurance competitors share information on customers such as credit worthiness
137How can published information, credit reference agencies and legal sources of credit information help to assess creditworthiness?1) Published information - customer's own annual accounts and reports give some idea of general financial position of entity and its liquidity
2) Credit reference agencies - e.g. Dunn & Bradstreet publish general financial details of entity with a credit rating (also produce special report on an entity if requested for a fee)
3) Legal sources of credit information - could check legal records for any history of insolvency or non-payment (e.g. UK information for Register of County Court Judgements/ Individual Insolvency Register)
138How can entity's own sales records, credit scoring and credit ratings help to assess creditworthiness?1) Entity's own sales records - for an existing customer, sales ledgers will show how prompt a payer the entity is although cannot show ability to pay
2) Credit scoring - indicators such as family circumstances/ home ownership/ occupation etc can be used to predict creditworthiness. Can be useful when extending information to public with little other information - variety of software packages can help
3) Credit ratings (large corporate customers only) -very large customers may have a credit rating from a major credit rating agency
139What is key to consider when setting credit limits?Two limits that need to be set (might be adjusted in accordance with risk profile of customer):
1) amount of credit available
2) length of time allowed before payment is due
140What should 'risk' associated with a customer's credit status be based on?1) customer's payment record and history of prompt or late payments
2) any new information that is obtained about the customer (e.g. from its most recent annual financial statements or recent press reports)
NB - level of credit available and length of settlement period offered to customer (if standard terms not used) should be based on assessment of the risk
141What is key to invoicing and collecting overdue debts?*Credit period only begins once invoice is received - prompt invoicing is essential!
*If debts are overdue, risk of default increases so need follow-up procedures to chase (bearing in mind risk of offending high valued customer) e.g.
1) reminder letter - regarded as relatively poor way of obtaining payment as easily ignored. Send by email rather than post to avoid claims not received.
2) telephone calls - efficient to speed up and identify problems at an early stage
3) withholding of supplies - 'stop list' for further orders may encourage settlement of debts
4) debt collectors - and trade associations - offer service on fixed fee basis or 'no collection, no charge' terms. Need to consider quality of service when choosing agent
5) legal action - often seen as last resort. Solicitor's letter may prompt payment. Court action not usually cost effective but can discourage others.
142How can credit control staff be motivated?*COLLECTION TARGETS*
- employees in collection teams need to be convinced of their value of work and contribution to operate effectively
- Can improve performance/ increase motivation by setting collection targets - a target for the amount of payments to collect for trade receivables within a period of time - could then get a bonus
- targets for 1) individual members of team, 2) credit control team as a whole
143How can position of receivables be monitored?*Needs to be regularly reviewed as part of managing overall working capital and corrective action taken when needed
*Includes:
1) age analysis - of outstanding debts, a list of customers owing, total amount owed and time brackets for which money has been owed. Invoices allocated to month issued then when payment received it is taken off analysis. Can be difficult if customer pays a lump sum rather than individual invoices. Need to carefully adjust for credit notes/ discounts etc. Can help feed into cash cycles.
2) ratios - compared with previous period/ target to indicate trends in credit levels and incidence of overdue/ irrecoverable debt
3) statistical data - to identify causes of default and incidence of irrecoverable debt over customers/ types of trade
*Need to consider for working capital investment
144What is the calculation for the cost of financing receivables?Finance cost = receivable balance X interest (overdraft) rate
NB receivable balance = sales X (receivables days/ 365)
145What is key to early settlement discounts?*Cash discounts given to encourage early payment by customers
*Cost of discount balanced against savings entity received from having less capital tied up due to lower receivables balance and shorter average collection period
*Discounts could reduce number of irrecoverable debts
Annual cost of discount = ((1+(discount/ amount left to pay)^number of periods - 1
(where number of periods = 365/52/12/ number of days/weeks/ months earlier money is received)
NB - annual discount alway based on amount left to pay (amount net of discount). If cost of offering discount exceeds rate of overdraft interest, discount should not be offered
146What is the effective annual cost of a discount?ANNUAL RATE OF INTEREST IMPLIED IN A CASH DISCOUNT:
- use simplified annual cost formula
(100/ (100- discount%))^number of periods - 1
147How can you evaluate a change in credit policy?*May need to revaluate in exam whether proposed change in credit policy is financially justified
*Read question carefully - consider
1) reduction in level of working capital investment
2) consider annual costs and benefits of changing credit policy (recognise the saving in finance costs as result of reduction in level of working capital investment)
148What is key to accounts receivable factoring?FACTORING - sale of debts to a 3rd party at a discount in return for prompt cash - improves cash flow and liquidity
*Often the factor advances up to 80% of the debt. Remainder (minus fees) paid when debt collected. Finance costs usually 1.5% to 3% above bank base rate and interest charged on daily basis
*Debts of entity sold to a factor (normally owned by a bank) who takes responsibility for collecting debts for a fee
*Services could be
1) debt collection and administration - recourse or non-recourse (this is more expensive than recourse as factor bears cost of any irrecoverable debts). Factor takes over whole of entity's sales ledger issuing invoices and collecting debts
2) credit insurance - factor agrees to insure irrecoverable debts of client. Factor then determines whom entity was able to offer credit.
* Of particular value to 1) smaller firms, (who cannot afford sophisticated credit/ sales accounting systems) 2) fast growing firms (substantial/ growing investment in receivables that can be turned to cash by factoring debts - more flexible than overdraft or loan)
149What are the advantages and disadvantages of factoring?ADVANTAGES
1) saving in administration costs
2) reduction in need for management control
3) useful for small and fast growing businesses where credit control department not able to keep pace with volume growth
DISADVANTAGES
1) likely more costly than efficiently run internal credit control dept.
2) Factoring has bad rep. associated with failing companies - using a factor may suggest company has money worries
3) Customers may not wish to deal with a factor
4) Once you start factoring it's difficult to revert easily to internal credit control system
5) Company may give up opportunity to decide whom credit may be given (non-recourse factoring)
150What are benefits of factoring?1) Business improves cash flow - factor provides finance for up to 80% of more debts within 24hrs of invoices being issued. Bank providing overdraft facility secured against an entity's unpaid invoices normally lend up to 50% of invoice value
2) Factor can save entity administration costs of keeping sales ledger up to date and costs of debt collection
3) If the business were to allow factor to administer sales ledger - can use factor's credit control system to assess creditworthiness of both new and existing customers
4) Non-Recourse factoring a convenient way of obtaining insurance against irrecoverable debts
151What are problems with factoring?1) Although factors provide valuable services, entities sometimes wary to use them. Possible problem with factoring is that the intervention of the factor between factor's client and credit customer could endanger trading relationships and damage goodwill. Customers might prefer to deal with the business, not a factor
2) When non-recourse factoring service used, client looses overall control over decisions about granting credit to customers
3) For this reason, some clients may wish to retain risk of irrecoverable debts and opt for 'with recourse' factoring service. With type of service, the client and not factor decides extreme (legal) action and should be taken against non-payer
4) When suppliers and customers of client find out client using factor to collect debts it may arouse fears that entity beset by cash flow problems, raising concerns about viability. Suppliers may then impose more stringent payment terms, thus negotiating the benefits provided by factor
152What is key to accounts receivable invoice discounting?INVOICE DISCOUNTING - a method of raising finance against security of receivables without using sales ledger administration services of a factors
*While specialist invoice discounting firms exist service is also provided by factoring entities
*Selected invoices used to security against which entity may borrow funds
*Temporary source of finance, repayable when debt is cleared
*Key advantage is that it is confidential service - customer doesn't know about it
*In some ways it is similar to financing of the factoring service without control of credit passing to the factor
153What is the typical arrangement for invoice discounting?1) Company sells goods to customer payable in 30 days
2) Company borrows up to 80% of the value of the debt
3) The company receives payment
4) Company pays the invoice discounter the amount borrowed plus interest
154How does invoice discounting work?*Invoice discount method of raising finance against security of receivables without using sales ledger administration services of a factor
*Business retains control over its ledger and confidentiality in its dealings with customers
*Firms of factors also provide invoice discounting clients
*Admin charges around 0.5-1% of client turnover
*More risky than factoring since client retains control over credit policy - usually constrained to established entities with high sales revenue and business must be profitable
*Finance costs usually 3-4% above base rate, although larger entities with credit insurance may receive better terms
*Invoice discounter will check sales ledger of client regularly to ensure debt collection procedures adequate
155What is the method of invoice discounting?1) Business sends out invoices, statements and reminders in normal way and collects debts. With 'confidential invoice discounting' its customers are unaware that business is using invoice discounting
2) Invoice discounter provides cash to business for a portion of the value of the invoice as soon as it receives copy of the invoice and agrees to discount it. Discounter advances up to 80% of face value
3) When business collects payment from customer, money paid into a bank account controlled by the invoice discounter. Discounter then pays remainder of invoice, less interest and admin charges
156What is key to accounts payable and managing trade credit?*Trade credit is the simplest and most important source of short term finance for many entities
BALANCE LIQUIDITY (dealing payments to suppliers to obtain 'free' source of finance) and PROFITABILITY (dealing too long may cause long term difficulties(
157What are possible problems from delaying payments to suppliers?1) Suppliers may refuse to supply in future
2) Suppliers may only supply on a cash basis
3) there may be a loss of reputation
4) suppliers may increase price in future
*Trade credit is normally seen as a 'free' source of finance, but supplier may offer discount for early payment so if delaying payment it is no longer free as cost will be the lost discount
158What is key to trade payables?*Using trade credit a firm about to obtain goods/ services without immediate payment with supplier accepting firm will pay at a later date
*Very from industry to industry - generally accepted norm from 7 days up with typical credit period of 30 days
*Scope for flexibility can exist and longer credit periods sometimes offered, particularly if type of business activity requires long period to convert materials to saleable products (e.g. farming)
*Some suppliers may offer settlement discounts, but if firm short of funds it may wish to make maximum use of credit period given
*Favourable credit terms may be an influence to using a supplier
*Costs associated with extending credit taken beyond the norm e.g. lost discounts, loss of supplier goodwill, more stringent terms for future sales
*To compare cost of different sources of finance, all costs usually converted to rate per annum basis - cost of extended trade credit usually measured by loss of discount
159What is key to consider if you as the customer are wanting to extend credit terms beyond those offered (delayed payment)?*Assumptions can be made based on 1) maximum delay in payment that can be achieved before supply of goods withdrawn 2) availability of alternative sources of supply
*Its a mistake to reduce working capital cycle by holding onto creditors money for a longer period than allowed as in long term it'll affect supplier's willingness to supply and cause embarrassment to the firm
160What is key to age analysis of payables?*Value of an age analysis of trade payables is probably less obvious than value of age analysis of trade receivables but management to be aware of:
1) total amount payable to suppliers
2) when money will be payable
3) amounts payable to each individual supplier and how close this is to the credit limit available from the supplier
4) whether entity is failing to pay its trade suppliers on time
161What are the objectives of inventory management?*Inventory is a major investment for many entities - manufacturing could carry 3-6 months of sales depending on source of inventory/ relative powers of suppliers
*Essential therefore to reduce level of inventory to necessary minimum
*BALANCE LIQUIDITY (reducing inventory to lowest possible amount to minimise level of capital employed (CE) to be funded and PROFITABILITY (ensuring sufficient inventory held so that it does not run out and disrupt business)
162What are costs of high inventory levels?*Keeping inventory levels high is expensive due to:
1) forgone interest lost from typing up capital in inventory
2) holding costs:
a) storage
b) stores administration
c) risk of theft/ damage/ obsolesce
*Major working capital investment and levels need to be tightly controlled
*Cost is not just purchasing goods but also storing/ insuring/ managing them once in inventory
*Specialist equipment may need to be used to transport inventory/ staff needed to manage warehouse/ security/ investment for inventory control systems
*Longer inventory is held, greater risk it will deteriorate or become out of date (true for perishables/ fashion items/ high tech products)
163What may be costs of low inventory levels?*If inventory levels kept too low, business could face:
1) stock outs, leading to:
a) lost contribution - dissatisfied customers could lead to lost orders
b) production stoppages - could cause idle time, stockpiling and WIP or missed orders
c) emergency orders - may be more expensive/ poorer quality suppliers
2) High reorder/ setup costs - goods in costs in terms of admin (purchase requisition/ authorisation of order/ placing orders/ GRN and settling invoice)
3) Lost quantity discounts - purchasing items in bulk will often attract discount
164What is the challenge of good inventory management?1) Optimum reorder levels - how many items should be left in inventory when next order placed
2) Optimum reorder quantity - how many items should be ordered when order is placed
- need to strike balance between holding costs on one hand and stock-out and reorder costs on the other..
- balancing act between liquidity and profitability which might be considered a trade-off between holding costs and stock out/ reorder costs - key to inventory management discussions
165What key terms are there for inventory management?1) Lead time - lag between when order placed and the item is delivered
2) Buffer inventory - the basic level of inventory kept for emergencies. Buffer required because demand and lead time will fluctuate and predictions can only be based on best estimates
3) Reorder level
4) Reorder quality
166What is key to economic order quality (EOQ)?*For businesses not using JIT inventory management systems, there is an optimum order quantity for inventory items - EOQ
*Aim of EOQ model is to minimise total cost of holding and ordering inventory
SEE FORMULA
EOQ = sqr root (2C0D/ CH)
- Co = cost per order
- D = annual demand
- CH = cost of holding one unit for one year
167What assumptions are made in EOQ?1) Demand and lead time are constant and known
2) Purchase price is constant
3) No buffer inventory held as it is assumed that it is not needed since demand and lead times are known with certainty
NB - these assumptions are critical and should be discussed when considering the validity of the model and its conclusions (e.g. in practice, demand and/or lead time may vary)
168What is key in terms of holding costs for explanation/ derivation of EOQ?*To minimise total cost of holding inventory, necessary to balance relevant costs:
1) variable costs of holding inventory
2) fixed costs of placing the order
HOLDING COSTS:
- the EOQ model assumes certain amount to hold a unit of inventory for a year (as average level of inventory increases, so will total annual holding costs incurred)
- assumption that demand per period is known and constant allows conclusions to be drawn over average inventory level in relationship to order quantity
*When new batches/ items purchased assumes a given patters of inventory levels over time (SEE DIAGRAM)
*If x is quantity ordered, annual holding cost calculated as CH x (X/2)
- this gives upward sloping linear relationship between reorder quantity and total annual holding costs
169What is key in terms of ordering costs for explanation/ derivation of EOQ?*Model assumes that a fixed cost is incurred every time an order is placed (CO in the formula) - therefore as order quantity increases there is fall in number of orders needed, which reduced total order cost
*If D is annual expected sales demand, annual order cost calculated as: CO X (D/x)
*Fixed nature of the costs results in downward sloping, curved relationship
170What is key in terms of total costs for explanation/ derivation of EOQ?*Because we try to balance holding and ordering costs (one which increase as reorder quantity increases and one which falls), total costs will be minimised at point where total holding costs = total ordering costs
*SEE DIAGRAM
*This point is the economic order quantity (EOQ), where reorder quantity chosen minimises total cost of holding and ordering
171How can quantity discounts be dealt with in terms of EOQ?*Discounts may be offered for ordering in larger quantities - if EOQ is smaller than order size needed for discount, consider if order size to be increased above EOQ..
1) Calculate EOQ, ignoring discounts
2) If EOQ is below quantity qualifying for discount, calculate total annual inventory cost )including purchase cost of inventory) arising from using the EOQ
3) Recalculate total annual inventory costs (including purchase cost of inventory) using order size required to obtain each discount
4) Compare cost of Steps 2 and 3 with saving from the discount and select minimum cost alternative
5) Repeat for all discount levels
172What are criticisms of EOQ?1) Based on simplifying assumptions (e.g. constant and predictable material usage rates)
2) Will not indicate optimal purchase quantity when there are price discounts for buying in larger quantities
3) Ignores problems of managing stock-outs
4) Is inconsistent with philosophy of JIT and TQM
173What is key to inventory management systems?*Number of systems have been developed to simplify inventory management processes:
1) Periodic Review
2) JIT
NB SOLW MOVING INVENTORY to be considered - certain items have high individual value but infrequent demand (80/20 rule considers 20% items held make up 80% usage)
- management need to review inventory usage to identify slow-moving inventory using aged inventory analysis (could then eliminate obsolete items/ only order when needed/ review demands)
174What is key to Periodic Review in terms of being an inventory management system?*constant order cycle system*
- inventory levels reviewed at fixed intervals
- inventory in hand made up to a predetermined level which considers 1) likely demand before next review 2) likely demand during lead time
- e.g. a 4 weekly review with 2 week lead time whole demand inventory to maximum demand for next 6 weeks
175What is key to JIT in terms of being an inventory management system?*JIT is a series of manufacturing/ supply chain techniques that aim to minimise inventory and improve customer service by manufacturing at exact quantity/ time customers require to save costs (competitive pricing!)
- balancing act where inventory reduced to absolute minimum/ reduced all together
- involves elimination of all activities performed that do not add value - this is waste!
AIMS:
1) smooth flow of work through manufacturing
2) flexible production process responsible to customer requirements
3) reducing in capital tied up in inventory
176What is considered waste in a JIT system?*Not just inventory - considers all wastes:
1) raw material inventory
2) WIP inventory
3) finished goods inventory
4) materials handling
5) quality problems (e.g. rejects/ reworks)
6) Queues/ delays on shop floor
7) Long raw material lead times
8) Long customer lead times
9) Unnecessary clerical and accounting procedures
177How does JIT attempt to minimise waste?1) in WIP - reduce batch sizes (often to one)
2) in raw materials inventory - by suppliers delivering straight to shop floor for use
3) in scrap/ rework - by emphasising total quality control of design/ process and materials
4) in finished goods inventory by reducing lead times so all products made to orders
5) in material handing costs, by redesign of shop floor so goods move directly between adjacent work centres
178What are benefits of JIT?*JIT manufacturer looks for single supplier who can provide high quality, frequent and reliable deliveries rather than lower price. Supplier gets more long term POs giving greater certainty
*Long term contracts/ single sourcing tend to give better quality product
*Inventory problems shifted to suppliers, deliveries only made as required
*Spread of JIT in production process inevitably affects delivery and transportation - smaller, more frequent loads required at shorter notice (supplier likely to be nearby!)
*Inventory ordering costs will be high, but saves in admin of counting inventory/ storage costs etc
179What is key to inventory control systems?Main systems to monitor and control inventory levels:
1) Reorder level system (where inventory ordered at a particular, set order level) - replenishment order made when current inventory falls below predetermined level. Lead times mean can be gap betweens so buffer inventory held. Known as a two bin system inventory in 1) amount equal to ROL quantity and 2) the rest. Inventory drawn from 2) until runs out
2) Periodic review system (where inventory checked and ordered at set periods of time) - 'constant cycle' system. Replenishment ordered issued where necessary to top up inventory to pre-set target levels (order sizes variable)
3) Mixed systems incorporating both
180How are reorder levels calculated with a known demand/ lead time?*Once amount of inventory to reorder is decided, need to know when to reorder - identify level of inventory which can be reached before order needs to be placed
**ROL = quantity of inventory on hand when order is placed**
*When demand and lead time known with certainty, ROL = demand in lead time
181How are reorder levels calculated with variable demand/ variable lead time?ROL will = maximum demand x maximum lead time
- leads to creation of buffer stock
182What is key to buffer stock?*Buffer stock is quantity of inventory that should not normally be needed but might be if actual demand during supply lead time exceeds average demand or lead times longer than expected
*Buffer stok has a cost - annual cost of holding is amount of buffer stock X annual holding cost per one unit of the inventory item
SEE FORMULA
Optimum levels of buffer stock will depend on:
1) variability of demand
2) cost of holding inventory
3) cost of stock-outs
183What is key to inventory warning levels?*Two wanting levels may be used to indicate when quantity of item in inventory is:
1) higher than expected or
2) below buffer stock level
*If quantity of inventory above maximum level or below minimum, inventory managers should monitor carefully and take appropriate control measure
* MAXIMUM level should be = reorder level + reorder quantity - (min demand per time (units)) x min reorder lead time) - will occur when order delivered, if lead time at minimum and demand at minimum during lead time
*MINIMUM level should be buffer inventory level = reorder level - (average demand per time (units)) x average reorder lead time
184What are reasons for holding cash?*Cash needs to be invested to earn returns, but ready cash needed for:
1) Transactions motive - day to day expenses (e.g. payroll etc)
2) Precautionary motive - for unplanned expenditure
3) Investment/ speculative motive - cash kept available to take advantage of market investment opportunities
185What can failure of carrying sufficient cash levels lead to?1) Loss of settlement discounts
2) Loss of supplier goodwill - trade refuse to offer further credit/ charge higher prices or downgrade priority of order process
3) Poor industrial relations - if wages not paid on time. Can damage production in short term and relationships/ motivation in medium term
4) Potential liquidation - court may be petitioned to wind up entity if consistently fails to pay bills when due
186What is the balancing act of efficient cash management?*Amount of cash available will depend on efficiency of cash flow management
*Need to:
1) collect debts as quickly as possible
2) pay suppliers as late as possible
3) bank cash takings promptly
BALANCING ACT OF LIQUIDITY - ability to pay bills as fall due and take advantage of opportunities and PROFITABILITY - minimising cash holding (idle asset) for better investment
187What is key to cash forecasts/ budgets?CASH FORECAST (AKA CASH BUDGET): an estimate of cash receipts and payments for a future period under existing conditions
Used to:
1) assess and integrate operating budgets
2) plan for cash shortages/ surpluses
3) compare with actual spending
Two techniques for creating cash budget:
1) receipts and payment forecast - based on sales predictions and cost of sales. Timing of cash flows also needs consideration.
2) SOFP forecast
188What is key to preparing forecasts from planned receipts and payments?*Every type of cash inflow and receipt, with its timings, must be forecast
*NB differs from from sales and cost of sales in SOPL as:
1) not all cash receipts/ payments affect SOPL (e.g. new shares/ purchase of non-current asset)
2) Some SOPL items derived from accounting conventions and are not cash flows (depreciation etc)
3) Timing of cash receipts/ payments doesn't coincide with SOPL accounting period (e.g. sale made on credit)
4) Irrecoverable debt expense not a cashflow as represent amounts from customers not expected to be recovered
189How can forecasts be prepared from planned receipts and payments?TO PREPARE:
1) Prepare pro forma - to include 1) clear distinction between cash receipt/ payments for each period. Needs to be logically arranged with subtotals for reciepts/ payments. 2) Figure for net cash flow for each period. 3) Closing cash balance for each period (opening for next!)
2) Fill in simple figures - e.g. wages/ fixed overhead expenses/ dividend payments
3) Work out more complex figures - consider timings for sales/ purchases found from credit periods. Variable overheads need production values. Purchases may need calcs based on production schedules...
190What is key to preparing forecasts from planned receipts and payments?*Forecast derived from predictions of future SOFPs. Made of all items exact cash which is derived as a balancing figure
*Used to predict cash balance at end of given period - typically requires forecast of:
1) changes to non-current assets (acquisitions and disposals)
2) future inventory levels
3) future receivables levels
4) future payables levels
5) changes to share capital and other long-term funding (e.g. bank loans)
6) changes to retained profits
191What needs to be considered when interpreting cash forecast?1) Is the balance at the end of the period acceptable/ matching expectations
2) Does cash balance become a deceit at any time in the period
3) Is there sufficient finance (e.g. overdraft) to cover cash deficits/ should new sources of finance be sought in advance?
4) What are key causes of cash deficits?
5) Can/ should discretionary expenditures (e.g. asset purchases) be made in another period in order to stabilise pattern of cash flows?
6) Is there a plan for dealing with cash surpluses (e.g. reinvest elsewhere)?
7) When is best time to make discretionary spend?
192How are spreadsheets used in cash forecasting?USEFUL as:
1) save time in preparing forecasts. When basic 'model' is constructed, relatively simple task to inset figures to model, and leave it to the model to produce the completed forecast. Model once established can be used whenever new forecast is required
2) Useful for 'what if' analysis. When there is uncertainty in forecast, assumptions for the forecast can be changed and an alternative forecast produced. Allows management to consider a range a different possible outcomes, without needing much time/ effort
3) Cash flow forecasts can be consolidated. E.g. if same model used to prepare cash forecasts for each division, or region in the entity, model can automatically produce consolidated cash flow forecast for entity as whole
193What is key to what if analysis?*When budgets prepared, v. large number of assumptions/ estimates (e.g. estimated sales each month, estimates of costs, assumptions about when receivables pay when suppliers will be paid etc) - any estimates/ assumptions could be inaccurate
*Benefit of spreadsheets to prepare cash budgets make it easier to carry out what if analysis
*When asking 'what if', can find out how expected results will change if some forecasts/ assumptions altered
194What is key to consolidation?*Spreadsheets can consolidate individual cash flow forecasts for business units to one forecast for organisation as a whole
INDIVIDUAL FORECASTS can be prepared by:
1) various group entities
2) individual operating units (e.g. retail store branches)
3) individual cost centres (e.g. stores/ purchasing/ production etc)
4) individual budget holders (e.g. marketing)
NB if all individual forecasts prepared using same software it will be possible for these to be uploaded to a central computer, programmed to produce consolidated forecast
195What measures could be taken to improve a cash forecast situation?*Initial cash forecast may predict unsatisfactory cash flow situation (e.g. cash deficit that cannot be met by existing short-term borrowing arrangements e.g. bank overdraft facility)
*When situation occurs, will need to manage future cash flows to improve forecast position. Nature of the management action will depend on:
1) if forecast indicates continuing trend of increasing deficit or is there movement between surplus and deficit seasonally
2) What size of cash surpluses are there/ how long will they be available
3) Are the forecast cash deficits within current overdraft facility
4) Which cash flows are discretionary/ either in size/ timing
196How can cash deficits arise from?1) Basic trading factors underlying the business, e.g. falling sales/ increasing costs. To correct these, normal business measures need to be taken. Sales may be improved by increased marketing activity/ revised pricing policies. Cost cutting exercises may be needed
2) Short term deficiencies in working capital cycle (e.g. long average holding period for inventory/ long average time to pay credit customers)
197What could be done to deal with forecast short term cash deficits?1) Additional short term borrowing
2) Negotiating a higher overdraft limit with bank
3) Sale of short-term investments if entity has any
4) Using different forms of financing to reduce cash flows in short term (e.g. leasing instead of buying outright)
5) Changing amount of discretionary cash flows/ differing expenditures or bringing forward revenues e.g.
a) reducing dividend to shareholders
b) postponing non-essential capital expend
c) bringing forward planned disposal of non-current assets
d) reducing inventory levels (e.g. use JIT, but will take time to implement)
e) shortening operating cycles by reducing time taken to collect receivables, perhaps offering discount or using factor/ invoice discounting
f) shortening operating cycle by delaying payment to payables
198What is key to cash surpluses?*If forecast shows cash surpluses, need to be dealt with including size/ duration
*Management should consider policy for how surplus cash should be invested so as to achieve a return on the money, but without investing in items where risk of a fall in value is considered too high
*Interest/ other return earned can be used to improve overall cash position
*Care must be taken to ensure investments can be realised as needed to fund forecast deficits
*Where long term cash surpluses are forecast, management might consider other possible uses of surpluses e.g. paying a higher dividend/ repaying loans
199—

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Descrição: FlashCards sobre F1 pt2, criado por P H em 31-07-2024.
Criado por: P H
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