Chapter 10 - Working capital management - cash and funding strategies

Question 1

What are the motives for holding cash?

Answer 1

• transactions motive (day-to-day expenses)
• precautionary motive - meet unplanned expenditure
• investment motive - to take advantage of investment opportunities

Question 2

Failure to hold enough cash can lead to what?

Answer 2

• loss of settlement discounts
• loss of supplier goodwill
• poor industrial relations
• potential liquidation

Question 3

What is a cash forecast?

Answer 3

• An estimate of cash receipts and payments for a future period under existing conditions

Question 4

What is a cash budget?

Answer 4

• a commitment to a plan for cash receipts and payments for a future period after taking any action necessary to bring the forecast into line with the overall business plan

Question 5

Cash budgets are used for what?

Answer 5

• assess and integrate operating budgets
• plan for cash shortages and surpluses
• compare with actual spending

Question 6

Cash forecasts are used for what?

Answer 6

• a receipts and payments forecast
• a statement of financial position forecast
• working capital ratios

Question 7

What are the 2 cash management models?

Answer 7

Baumol model
The miller-orr cash management model

Question 8

cash management models are aimed at minimising the total costs associated with movements between what?

Answer 8

• a current account
• short-term investment

Question 9

What is the baumol model?

Answer 9

it is based on the economic order quantity (EOQ)

Question 10

When is the baumol model most useful?

Answer 10

when cash balances move steadily in one direction over time

Question 11

What is the miller-orr model?

Answer 11

controls irregular movements of cash by the setting of upper and lower control limits on cash balances

Question 12

When is the miller-orr model most useful?

Answer 12

when cash balances fluctuate up and down over time

Question 13

When are short-term cash investments required?

Answer 13

if a business has a temporary cash surplus

Question 14

To weigh up an investment a company has to weigh up what 3 potential conflicting objectives and factors?

Answer 14

liquidity
safety
profitability

Question 15

What are the 2 main sources of bank lending?

Answer 15

• bank overdraft
• bank loans

Question 16

Current assets are made up of what 2 elements?

Answer 16

• permanent
• fluctuating

Question 17

What are permanent current assets?

Answer 17

the proportion of current assets that are effectively ‘fixed’ e.g., buffer inventory levels, minimum receivables and minimum cash balances

Question 18

what are fluctuating current assets?

Answer 18

the proportion of current assets that changes e.g., inventory above the buffer level, receivables above the minimum level

Question 19

Short-term sources of funding working capital is what?

Answer 19

cheaper due to lower risk for investor, but more risky as may not be renewed

Question 20

long-term sources of funding working capital is what?

Answer 20

more expensive than short-term but less risky