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Chapter 7 Short-term Financial Assets Managing Cash needs during seasonal cycles Figure 1 – page 342 Assignment 1-2 page report on a company’s business cycle ex: Home Depot. Include receivable turnover rate Average day’s sales uncollectible Credit Policies Credit policies

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Chapter 7 l.jpg

Chapter 7

Short-term Financial Assets


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Managing Cash needs during seasonal cycles

  • Figure 1 – page 342

  • Assignment

    • 1-2 page report on a company’s business cycle ex: Home Depot.

    • Include receivable turnover rate

    • Average day’s sales uncollectible


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Credit Policies

  • Credit policies

    • Increase sales

    • Be competitive

  • Credit department policies

    • Control procedures

      • Approval of customers

        • Check references


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Liquidity – 3 Key Issues

  • Plan for cash inflows, outflows, borrowing, and investing

  • Minimize the risk of bad debts due to sales on credit by establishing policies and procedures for checking credit

  • Ratios - check for effectiveness of policies

    • Receivable turnover ratio: net sales/average net receivable

    • Average days’ sales uncollectible: 365/rec turnover


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Accounts Receivable Turnover

Net Credit Sales

Average Accounts Receivable

Indicates how quickly a company is collecting (i.e., turning over) its receivables


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Average day’s sales uncollectible

  • A measure that shows on average how long it takes to collect accounts receivable

  • Figure 2 – pg. 7 and Figure 3 – pg. 8

    Average days’ sales uncollectible =

    365 days/receivable turnover


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Discounting Accounts Receivables

  • Two popular arrangements used for the discounting or sale of accounts receivable are factoring and securitization. The sale of accounts receivable can be made without recourse or with recourse.

  • 1. The buyer assumes the risk of uncollectibility when accounts receivable are sold without recourse, and the transfer is accounted for as a sale. The typical factoring arrangement is made without recourse.

  • 2. The seller retains the risk of uncollectibility when accounts receivable are sold with recourse. If certain criteria are met, factoring with recourse is accounted for as a sale; otherwise, its accounted for as a borrowing.


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Baker Corporation promises to pay High-Tec, Inc. $15,000 plus 12% annual interest on

December 31, 1998.

Date: January 1, 1998

Signed:_________

Discounting Notes Receivable

  • Sell note prior to maturity date for cash

  • Receive less than face value (i.e., discounted amount)

  • Can be sold with or without recourse


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Factoring plus 12% annual interest on

Factoring involves selling accounts receivable to a factoring company at a certain percentage of face value. The company receives cash right away from the factoring company.

The factoring company typically bears the default risk, bears the cost of financing the account and bears any collection costs.


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Securitization of Accounts Receivable plus 12% annual interest on

Securitization of accounts receivable refers to selling a portfolio of accounts receivable in the financial markets.

Each investor effectively buys a proportional share in the accounts receivable portfolio.


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Short-term financial assets plus 12% annual interest on

Assets that arise from cash transactions

  • Cash transactions

  • Investment of cash

  • Extension of credit


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Electronic Funds Transfer (EFT) plus 12% annual interest on

  • Transfers of funds between banks through electronic communication

    • ATM’s

    • Banking by telephone

    • Debit cards

    • Direct deposit for payroll checks

    • Direct deposit for Accounts Payable payments


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Short-term investments Held to Maturity plus 12% annual interest on

  • Marketable securities – ex: purchased $97,000 U.S. Treasury bills

    Short-term Investments 97,000

    Cash 97,000

    Accrued interest at year-end

    Accrued interest 750

    Interest Income 750

    • Journal entry to book at maturity

      Cash 100,000

      Short-term Investments 97,750

      Interest Income 2,250


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Trading Securities plus 12% annual interest on

  • Securities consist of both debt and equity securities that will be held for a short-time

  • Valued on the balance sheet at their fair value (market value)


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Principal plus 12% annual interest on

Interest

Maturity

Date

Interest-Bearing Promissory Note

Baker Corporation promises to pay High-Tec, Inc. $15,000 plus 12% annual interest on March 13, 2005.

Date: December 13, 2004

Signed:_________

Baker Corporation


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In exchange for $9,000 applied toward my purchase today, I promise to pay $9,900 in six months.

Date: November 1, 2004

Signed:_________

J.E. Privett

Non-Interest-Bearing Promissory Note

Effective interest rate on note = 20%

$900 12

$9,000 x 6


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Discount transferred to interest revenue over life of note promise to pay $9,900 in six months.

Balance Sheet Presentation of Discounted Notes

12/31/044/30/05

Notes receivable $ 9,900 $ 9,900

Less: Discount on

notes receivable ( 600) - 0 -

$ 9,300 $ 9,900

Upon

Maturity


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