Chapter 17

Question 1

speculative motive

Answer 1

The need to hold cash to take advantage of additional investment opportunities, such as bargain purchases.

Question 2

precautionary motive

Answer 2

The need to hold cash as a safety margin to act as a financial reserve.

Question 3

transaction motive

Answer 3

the need to have cash on hand to pay bills

Question 4

float

Answer 4

The difference between book cash and bank cash, representing the net effect of checks in the process of clearing.

Question 5

disbursement float

Answer 5

Check written by a firm but not cleared by the bank. Decreases the firm’s book balance, but no change in its available balance (according to bank)

Question 6

Collection float

Answer 6

Checks received by the firm but not cleared by the bank. Increases the firm’s book balance, but no change in available balance.

Question 7

Net float

Answer 7

sum of the total collection and disbursement floats

Question 8

float management

Answer 8

controlling the collection and disbursements of cash

Question 9

parts of collection or disbursement times

Answer 9

Mailing time
Processing delay
Availability delay

Question 10

Mailing time

Answer 10

The part of the collection and disbursement process during which checks are trapped in the postal system.

Question 11

Processing delay

Answer 11

the time it takes the receiver of a check to process the payment and deposit it in a bank for collection

Question 12

Availability delay

Answer 12

the time required to clear a check through the banking system

Question 13

EDI

Answer 13

Electronic data interchange. General term that refers to the practice of direct, electronic information exchange between all types of businesses.

Question 14

Zero-balance account

Answer 14

A disbursement account in which the firm maintains a zero balance, transferring funds in from a master account only as needed to cover checks presented for payment.

Question 15

Lockboxes

Answer 15

Special post office boxes set up to intercept and speed up accounts receivable collections.

Question 16

Cash concentration

Answer 16

The practice of and procedure for moving cash from multiple banks into the firm’s main accounts.

Question 17

Concentration banks

Answer 17

Pools the funds obtained from local banks contained within some geographical region.

Question 18

Controlled disbursement account

Answer 18

A disbursement practice under which the firm transfers an amount to a disbursement account that is sufficient to cover demands for payment. With a disbursement account, the bank informs the firm of the day’s total payments, and the firm transfers (usually by wire) the amount needed.

Question 19

Terms of sale

Answer 19

Conditions under which a firm sells its goods and services for cash or credit

Question 20

Credit analysis

Answer 20

The process of determining the probability that customers will or will not pay.

Question 21

Collection policy

Answer 21

Procedures followed by a firm in collecting accounts receivable.

Question 22

Elements of the terms of sale

Answer 22

1. The period for which credit is granted (the credit period).
2. The cash discount and the discount period.
3. The type of credit instrument.

Question 23

Credit period

Answer 23

The length of time for which credit is granted.

Question 24

Invoice

Answer 24

Bill for goods or services provided by the seller to the purchaser.

Question 25

When is the invoice date by convention?

Answer 25

Usually the shipping date or the billing date, not the date that the buyer receives the goods or the bill.

Question 26

What influences the length of the credit period?

Answer 26

The buyer’s inventory period and the operating cycle. All other thing’s being equal, the shorter these are, the shorter the credit period will normally be.

Question 27

Cash discount

Answer 27

A discount given to induce prompt payment. Also sales discount.

Question 28

Credit instrument

Answer 28

The evidence of indebtedness.

Question 29

Open account

Answer 29

Only formal instrument of credit is the invoice, which is sent with the shipment of goods and which the customer signs as evidence the goods have been received.

Question 30

Promissory note

Answer 30

Basic IOU. Might be used when order is large or when the firm anticipates a problem on collection. Uncommon. Can eliminate possible controversies later about the existence of debt.

Question 31

Commercial draft

Answer 31

Typically calls for the customer to pay a specific amount by a specific date. The draft is then sent to the customer’s bank with the shipping invoices.

Question 32

Sight draft

Answer 32

Commercial draft where immediate payment is required.

Question 33

Time draft

Answer 33

Commercial draft where immediate payment is not required.

Question 34

Trade acceptance

Answer 34

When a commercial draft is presented and the buyer “accepts” it, meaning that the buyer promises to boat it in the future. It is then sent back to the selling firm.

Question 35

Banker’s acceptance

Answer 35

The bank accepts the commercial draft, meaning that the bank is guaranteeing payment. Common in international trade.

Question 36

Carrying costs with grading credit

Answer 36

1. The required return on receivables. 2. The losses from bad debts. 3. The cost of managing credit and credit collections.

Question 37

Credit cost curve

Answer 37

Graphical representation of the sum of the carrying costs and the opportunity costs of a credit policy.

Question 38

What characteristics of a firm will lead it to offer credit more liberally than other firms

Answer 38

1. Excess capacity 2. Low variable operating costs 3. Repeat customers.

Question 39

Captive finance company

Answer 39

A partially or wholly owned subsidiary that handles the credit function for the parent company.

Question 40

Sources of credit information for credit anaylysis

Answer 40

Financial statements, credit reports on the customer’s payment history with other firms, banks, the customer’s payment history with the firm.

Question 41

Five Cs of credit

Answer 41

The five basic credit factors to be evaluated; capacity, character, capital, collateral, and conditions.

Question 42

Character in credit analysis

Answer 42

The customer’s willingness to meet credit obligations.

Question 43

Capacity in credit analysis

Answer 43

The customer’s ability to meet credit obligations out of operating cash flows.

Question 44

Capital in credit analysis

Answer 44

The customer’s financial reserves.

Question 45

Collateral in capital analysis

Answer 45

Assets pledged by the customer for security in case of default.

Question 46

Conditions in credit analysis

Answer 46

General economic conditions in the customer’s line of credit.

Question 47

credit scoring

Answer 47

The process of quantifying the probability of default when granting consumer credit.

Question 48

aging schedule

Answer 48

A compilation of accounts receivable by the age of each account.