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Chapter 7

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  1. Chapter 7 Short-term Financial Assets

  2. 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

  3. Credit Policies • Credit policies • Increase sales • Be competitive • Credit department policies • Control procedures • Approval of customers • Check references

  4. 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

  5. Accounts Receivable Turnover Net Credit Sales Average Accounts Receivable Indicates how quickly a company is collecting (i.e., turning over) its receivables

  6. 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

  7. 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.

  8. 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

  9. Factoring 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.

  10. Securitization of Accounts Receivable 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.

  11. Short-term financial assets Assets that arise from cash transactions • Cash transactions • Investment of cash • Extension of credit

  12. Electronic Funds Transfer (EFT) • 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

  13. Short-term investments Held to Maturity • 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

  14. Trading Securities • 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)

  15. Principal 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

  16. 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

  17. Discount transferred to interest revenue over life of note 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