While in a single name context ratings are often criticized for being lagging indicators of credit quality, classifying bonds by rating is one widely used method to reflect the behavior of different risk classes in credit markets.
Many market participants argue that spreads themselves and spread volatilities are more timely indicators of an issuer’s credit risk than ratings. They consequently prefer to split the universe in spread class buckets. The disadvantage of this method is that it leads to relatively unstable compositions of the individual buckets and is less convenient, because the major index providers do not calculate indices based on spread classes. Since the different rating buckets constitute the corporate bond market as a whole, there is clearly a correlation between overall market fluctuations and the spread changes of the different rating subportfolios.
The tactical asset allocation in credit portfolios combines top-down- and bottom-up analyses in order to arrive at medium- to short-term investment decisions. In this step of the investment process three major subjects are tackled:
- Spread class selection,
- Sector allocation, and
- Credit curve positioning.
When making a decision about the allocation of resources to different spread classes, elements of the top-down analysis clearly have a substantial impact, since the assessment of the fundamental and technical environment for credit and the valuation relative to other asset classes have significant influence on the positioning within the credit asset class. Conversely, credit curve decisions are usually implemented on a sector or, probably even more frequently, on a single issuer basis. Although elements of the bottomup analysis clearly influence the positioning on the credit curve, there are also some economy-wide indicators that have to be considered. Therefore, and with respect to the time horizon of investment decisions and their potential impact on active portfolio performance, the three abovementioned issues should constitute an own step in a structured investment process for credit portfolios.
The overall sentiment of investors towards the asset class corporate bonds is mirrored in mutual fund flows. Monthly and weekly statistics, for example, from Investment Company Institute, AIG and Trim Tabs, track the net flows into the major asset classes and their subcomponents. They also give an indication about the portion of cash held in mutual funds. The published numbers can help to explain movements in credit spreads that are not directly related to changes in the fundamental environment for credit. For example, they partly reflect risk appetite of investors. This is especially true, when looking at flows into high-yield bond funds. Major shifts in the asset allocation of institutional investors can also be observed from the data. Yet, published information on mutual fund flows tends to be behind the curve, in other words it is a lagging indicator for the activity of market participants and thus for credit spreads. But the analysis may help to spot long-term trends in the relative attractiveness of different asset classes.
Also known as predicting cash outflow, the technique of playing the floats allows companies to predict the time it takes vendors to receive and process payments as a way to capitalize on company cash. As long as the company operates ethically, it won’t break any laws or get into any financial hot water.
Most businesses have three float options to consider: the mail float (between the time the accounting department posts payment and the time the vendor receives it), the vendor’s internal processing float, and the bank system float.
Have you ever been in a situation when the rent was due but your bank account was just a little low, so you sent out a check to pay your rent, figuring that you could get to the bank and deposit your paycheck a day or two later, before the bank processed the check? If so, then you were playing the float. What you might have done out of desperation, businesses do as a strategy for managing cash flow.
Playing the float can maximize cash disbursement, but those making that decision must be aware of possible changes that can affect that float, including a change in financial institutions or electronic payment patterns. The float could disappear overnight and your company may not realize it until it’s too late.
A good ACCOUNTS PAYABLE system can be used to forecast a payment schedule based on cash availability, anticipated income, and past policy practices. Then line up vendors in payment order, according to preference. Some will grumble, but the smart ones know they have little choice. If they don’t play along, it will take that much longer to be paid.
Vendors unhappy with your company’s payment policies won’t be vendors very long. Give preferred suppliers priority status and reward them with more prompt payment. They will likely return the favor with better service and more understanding if your company really gets into a bind.
The purpose of ACCOUNTS PAYABLE is to keep track of your company’s payables in an orderly fashion. But the advantage is that it enables a company to manage cash disbursement, allowing better control of cash flow and maximizing the value of funds to the organization.
As a rule of thumb, vendors meeting a company’s most critical needs—whether it’s raw materials or the retail items that are most popular or allow the highest markup—are paid first. Others follow as funds become available.
Sometimes cash flow is controlled out of necessity. There may be a snag in production or a liquidity problem that will require withholding or reducing some payments until the crisis is over. If that happens, the situation should be explained calmly and honestly to vendors. Chances are they’ve all been there and understand.
They will most probably want an estimated payment date. That’s where the ACCOUNTS PAYABLE system comes in handy.
When all of that is done, match the total amount of the checks against at least one control total to make sure everything balances. Those control totals may include the total amount paid for all checks, the amount subtracted from the checking account, and the total from the A/F subledger summary posted to the general ledger. If these amounts all balance, then the process has been successfully completed.
At some point your company will also likely find itself having to record vendor credits and adjustments. That system works the same in your ACCOUNTS PAYABLE system as it does in accounts receivable. Credits may occur for such things as returned merchandise, disputed accounts, and error correction.
Accounts payable may be affected by adjustments— decreased by vendor credits, for example, or increased by interest charges on delinquent accounts. The danger isn’t great from inappropriate crediting, but be cautious nonetheless. These adjustments should be treated with as much care as adjustments to accounts receivable. Supporting documentation for any vendor adjustment should be required.
As part of the process, the ACCOUNTS PAYABLE will be recording purchases. Most of that information comes from the vendor invoices, including vendor name, amount, and payment terms. If the invoice doesn’t arrive before close of business at the end of the month, the amount is accrued through adjusting entries to the current period. (That’s where accrual accounting comes in.) The transaction process, whether automated or manual, follows the three steps outlined earlier.
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