Deck 17: The Management of Working Capital

Question 1

Incremental working capital needed to support seasonal peaks in sales is known as seasonal working capital.

Answer 1

False

Question 2

In the course of normal operations, firms incur short-term liabilities that partially offset the need to fund working capital assets. This is generally called automatic financing.

Answer 2

False

Question 3

Firms are required to commit capital to funding cash balances just as they commit capital to fund inventory, receivables, and fixed assets.

Answer 3

True

Question 4

A firm's net working capital reflects the amount of funds required to support its day-to-day routine operations. The word net reflects the fact that the requirement is net of spontaneous financing.

Question 5

The term working capital refers to the assets and liabilities required to operate a business on a day to day basis.

Question 6

Accruals represent spontaneous financing from things such as purchasing inventory on credit.

Question 7

Because of the short-term nature of working capital assets and liabilities, it is always necessary to support working capital with short-term borrowing. To do otherwise would violate the matching principle, which is of paramount importance in financial management.

Question 8

Policy decisions regarding inventories, accounts receivable, cash balances, and marketable securities can control the amount invested in these assets.

Question 9

Net working capital is the sum of all current assets.

Question 10

Spontaneous financing exists because vendors and employees are not generally paid for their products and services immediately.

Question 11

The maturity matching principle says that the maturity of financing should generally match the length of the project it supports.

Question 12

Typically, working capital assets are expected to be converted into cash within twelve months while liabilities are expected to be paid within twelve months.

Question 13

Spontaneous financing can take the form of current liabilities or long-term debt.

Question 14

Working capital assets typically include cash, accounts receivable, and inventories. The liabilities include payables, accruals, and all borrowing regardless of term to maturity, that is used to fund day-to-day operations.

Question 15

We say a working capital financing policy is conservative if short-term funding is used to support working capital.

Question 16

Banks like to make self-liquidating loans because they usually command higher interest rates than other loans.

Question 17

Net working capital is the difference between current assets and current liabilities.

Question 18

Loans are said to be self-liquidating if the project the funds support automatically generates the cash to repay the loan.

Question 19

In most companies, the level of working capital needed to operate efficiently varies with sales.

Question 20

The financial managers have little control over the level of current assets associated with a given volume of sales.

Question 21

A bank line of credit usually requires both interest payments and a commitment fee.

Question 22

A revolving credit agreement and a line of credit are nearly identical, with the exception that the bank becomes legally obligated when it agrees to a line of credit.

Question 23

By foregoing the prompt payment discount offered in terms of 1/10, net 30, the customer is effectively borrowing at rate of 36.5%.

Question 24

As long as the borrower adheres to the conditions set forth in a revolving credit agreement, the bank is obligated to advance funds up to the agreed limit.

Question 25

The only negative consequence of slow paying is that the particular vendor involved may refuse to make additional credit sales. If that happens the customer firm can always go to other vendors and get credit.

Question 26

When a factor does not assume the bad debt risk on accounts it purchases, the factoring relationship is said to be "without recourse."

Question 27

A firm can increase the size of the cash discount received by paying on the first day of the discount period rather than on the last day.

Question 28

Unlike accruals, the volume of trade payables is controllable by the financial manager.

Question 29

Financing long-term projects with short term financing is risky because the bank may refuse to renew the short-term loan when it comes due.

Question 30

The availability of funds under a line of credit is not guaranteed by the lender.

Question 31

Compensating balances refer to charges that compensate the bank for work it does to balance customer accounts.

Question 32

"Leaning on the trade" is an expression associated with a customer's insistence that vendors extend more liberal credit terms.

Question 33

Bank credit is a minor source of short-term financing for firms.

Question 34

Under a pledging agreement, the borrower offers its receivables as collateral for a loan.

Question 35

By foregoing the prompt payment discount offered in terms of 2/10, net 30, the customer is effectively borrowing at rate of 36.5%.

Question 36

Accruals tend to be directly related to a firm's level of operations.

Question 37

Payables financing is costless during the prompt payment discount period.

Question 38

Most spontaneous financing comes from trade payables created when vendors sell on credit allowing deferred payment.

Question 39

Virtually all accruals are best guess estimates of obligations arising from merchandise purchases for which vendor invoices have not yet been received.

Question 40

Commercial paper is similar to a bond, except that it is sold at a discount rather than having coupon payments and has a maturity of 9 months or less.

Question 41

Commercial paper is an example of marketable securities.

Question 42

Marketable securities are also referred to as near cash or cash equivalents.

Question 43

Cash reserved to make payments to vendors is an example of precautionary demand.

Question 44

The cash conversion cycle is the time it takes to convert a receivable into cash.

Question 45

Compensating balances can be stated as a percentage of the loan outstanding under a line of credit.

Question 46

Carrying excess cash is convenient but expensive because cash earns little or no return.

Question 47

Warehousing places the pledged inventory under the lender's legal and physical control.

Question 48

Due to administrative costs, warehousing is an expensive source of financing.

Question 49

The administrative reason for holding cash is to pay for emergency needs.

Question 50

When accounts receivable are pledged as collateral rather than factored, the lender assumes the default risk on the receivables.

Question 51

The main advantage of commercial paper is that its maturity is longer than that of a bank loan.

Question 52

In a pledging agreement the borrower is obligated for default on any account receivable.

Question 53

Factoring involves the sale of accounts receivable by the firm that originally generated the receivables.

Question 54

A revolving credit agreement is a guaranteed line of credit.

Question 55

By factoring its receivables, a firm converts them into cash immediately rather than having to wait for customer payment.

Question 56

The interest rate on commercial paper normally exceeds the prime rate.

Question 57

Marketable securities are liquid investments that can be held instead of cash but do not earn any return.

Question 58

Trust receipts identify the specific units of inventory pledged as collateral for a loan.

Question 59

Cash held for precautionary demand is to take advantage of unexpected opportunities.

Question 60

Excess cash can be invested in marketable securities which earn a modest return but are almost as liquid as cash itself.

Question 61

Transit float in the check clearing system is the time required for checks to clear through the banking system.

Question 62

The three broad issues involved in receivables policy are (1) which customers should receive credit and how much, (2) what terms of sale (due dates and discounts) should be extended to customers, and (3) how should customers who don't pay on time be handled.

Question 63

The fundamental benefit of offering trade credit is more sales.

Question 64

Float, or money tied up in the process of check clearing, consists of transit float arising from the administrative functions of the payee that delay the actual deposit of the check and processing float created in the Federal Reserve's check clearing system.

Question 65

A firm's financial managers should always attempt to set a credit policy that will result in no bad debts.

Question 66

The level of a firm's receivables is influenced solely by factors outside the financial managers' control.

Question 67

Compensating balances cannot normally be used for transactions.

Question 68

A firm's credit policy affects both its credit sales and its ACP.

Question 69

Criteria for extending credit to new customers usually involve the following issues:
(1) length of time in business
(2) adequate net worth
(3) an acceptable current ratio
(4) a "clean" credit record.

Question 70

The cash manager's goal is to minimize the firm's cash balances.

Question 71

Lock boxes are designed to reduce mail float.

Question 72

A lockbox system that accelerates cash collections also decreases a firm's receivables.

Question 73

A low level of cash may force the firm to interrupt operations.

Question 74

Processing float in the check clearing system is the time required for checks to clear through the banking system.

Question 75

More aggressive collection procedures will generally reduce credit sales.

Question 76

A lockbox system can eliminate processing float.

Question 77

A firm can avoid excess funds at regional banking facilities by using zero balance accounts, or ZBAs.

Question 78

A firm's cash includes currency, coins, demand deposit accounts in banks, and may include marketable securities.

Question 79

The cash conversion cycle is shorter than the operating cycle by the time it takes for the firm to pay its own bills.

Question 80

The more efficient the management of cash, the larger the amount of cash the firm needs to hold.