Question 1

Because money has time value, a cash sale is always more profitable than a credit sale.

Accepted Answer

The profitability of a cash sale versus a credit sale depends on various factors including the interest rate, the credit terms, the opportunity cost of capital, and the risk of default. A credit sale could potentially be more profitable if the terms of credit (including interest or fees) compensate for the delay in receiving payment.

Question 2

Famous Farm's payables deferral period (PDP) is 50 days (on a 365-day basis), accounts payable are $100 million, and its balance sheet shows inventory of $125 million.What is the inventory turnover ratio?

Accepted Answer

Inventory turnover ratio = Cost of goods sold / Average inventory
To calculate the average inventory, we can take the average of the beginning and ending inventory. However, we only have the ending inventory, which is $125 million.

To find the cost of goods sold, we need to use the following formula:
Cost of goods sold = Sales / (1 + Gross profit margin %)
We do not have information on sales or gross profit margin, so let's assume a gross profit margin of 40%. This means that the cost of goods sold is 60% of sales or 0.6 x Sales.

Let's solve for the inventory turnover ratio:
Inventory turnover ratio = (0.6 x Sales)/($125 million/2)
PDP = 50 days = (Payables) / (Cost of goods sold / 365)
Rearranging the formula:
Cost of goods sold = (Payables x 365) / PDP
Substituting the values:
Cost of goods sold = ($100 million x 365) / 50 = $730 million

Inventory turnover ratio = (0.6 x Sales) / ($125 million/2) = $438 million / $125 million = 3.5
We need to find the number of times inventory is sold and replaced in a year, so we take the reciprocal of the inventory turnover ratio:

Inventory turnover ratio = 1 / 3.5 = 0.29
Thus, the inventory turnover ratio is 5.84.

Question 3

Which of the following is NOT commonly regarded as being a credit policy variable?

Accepted Answer

Payments deferral period is not commonly regarded as a credit policy variable. Credit policy typically includes credit standards, credit terms (such as the credit period and cash discounts), and collection policy. Payments deferral period relates more to the terms of payment once credit has been extended, rather than the initial policy of extending credit.

Question 4

Which of the following statements is CORRECT?

Accepted Answer

If a firm can increase credit sales per day but shorten the length of its collection period (DSO), it can keep accounts receivable fairly steady. This is because it is collecting those credit sales faster, allowing for more frequent turnover and reducing the amount of outstanding credit balances.

Question 5

If a firm's suppliers stop offering cash discounts, then its use of trade credit is more likely to increase than to decrease, other things held constant.

Accepted Answer

If suppliers stop offering cash discounts, the firm may rely more on trade credit to finance its purchases, as it becomes a more attractive option compared to paying cash. Therefore, the use of trade credit is more likely to increase.

Question 6

Trade credit can be separated into two components: free trade credit, which is credit received after the discount period ends, and costly trade credit, which is the cost of discounts not taken.

Accepted Answer

Trade credit is separated into two components: free trade credit, which is credit received within the discount period allowing buyers to avoid any interest charges, and costly trade credit, which refers to credit used after the discount period has ended, often resulting in higher costs due to lost discounts and potential interest charges.

Question 7

For a zero-growth firm, it is possible to increase the percentage of sales that are made on credit and still keep accounts receivable at their current level, provided the firm can shorten the length of its collection period sufficiently.

Accepted Answer

If a firm can reduce its collection period, it can collect payment for credit sales faster, which would offset any increase in the percentage of sales made on credit and keep accounts receivable at their current level.

Question 8

If a firm sells on terms of 2/10 net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the 30-day credit period tells us that the credit department is functioning efficiently and there are no past-due accounts.

Accepted Answer

A DSO of 28 days does not necessarily indicate the absence of past-due accounts; it reflects the average collection period. Customers could still be paying after the discount period or even after the net period, contributing to the average.

Question 9

Not taking cash discounts is costly, and as a result, firms that do not take them are usually those that are performing poorly and have inadequate cash balances.

Accepted Answer

Not taking cash discounts can lead to higher costs for firms because they miss out on savings offered for early payment. This behavior is often indicative of firms that are struggling financially and have inadequate cash balances, as they are unable to take advantage of these discounts due to a lack of funds.

Question 10

Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.

Accepted Answer

The receivables-to-sales ratio measures the amount of credit that customers owe the firm, while the payables-to-sales ratio measures the amount of credit that the firm owes its suppliers. These two ratios are not necessarily directly related, and a high receivables-to-sales ratio does not necessarily mean that the firm also has a high payables-to-sales ratio.

Question 11

Krackle Korn Inc.had credit sales of $3,500,000 last year and its days sales outstanding was DSO = 35 days.What was its average receivables balance, based on a 365-day year?

Accepted Answer

The answer of Krackle Korn Inc.had credit sales of $3,500,000...

Question 12

Which of the following statements is CORRECT?

Accepted Answer

Statement B is correct because if a firm's Days Sales Outstanding (DSO) is equal to the net term of 30 days, it suggests that, on average, it takes 30 days for the firm to collect its receivables. If the firm offers a discount for early payment (2/10 net 30), but its DSO is still 30, it indicates that not all customers are taking advantage of the discount and some may indeed be paying late, leading to past-due accounts.

Question 13

If a firm busy on terms of 2/10 net 30, it should pay as early as possible during the discount period.

Accepted Answer

The answer of If a firm busy on terms of...

Question 14

Which of the following statements is CORRECT?

Accepted Answer

The answer of Which of the following statements is CORRECT?
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Question 15

Dimon Products' sales are expected to be $5 million this year, with 90% on credit and 10% for cash.Sales are expected to grow at a stable, steady rate of 10% annually in the future.Dimon's accounts receivable balance will remain constant at the current level, because the 10% cash sales can be used to support the 10% growth rate, other things held constant.

Accepted Answer

If Dimon's sales grow at a steady rate of 10% annually, then its accounts receivable balance will also increase as a result of the increase in credit sales. The statement that the accounts receivable balance will remain constant is therefore false.

Question 16

The four primary elements in a firm's credit policy are (1) credit standards, (2) cash discounts offered, (3) credit period, and (4) collection policy.

Accepted Answer

The four primary elements in a firm's credit policy are indeed credit standards, cash discounts offered, credit period, and collection policy.

Question 17

As a rule, managers should try to always use the free component of trade credit but should use the costly component only if the cost of this credit is lower than the cost of credit from other sources.

Accepted Answer

Using the free component of trade credit is the most cost-effective option for a manager. However, if the cost of costly component of trade credit is lower than the cost of credit from other sources, then it can be used.

Question 18

Changes in a firm's collection policy can affect sales, working capital, and profits.

Accepted Answer

Changes in a firm's collection policy can impact their ability to collect payments from customers, which in turn affects their cash flow, sales, working capital, and profits. A firm that tightens its collection policy may see an increase in cash flow, but it may also result in lost sales if customers find the policy too restrictive. On the other hand, a firm with a looser collection policy may have lower cash flow and profits due to slower payment collections. Therefore, changes to a firm's collection policy can have a significant impact on their financial performance.

Question 19

A firm's collection policy, i.e., the procedures it follows to collect accounts receivable, plays an important role in keeping its average collection period short, although too strict a collection policy can reduce profits due to lost sales.

Accepted Answer

A firm's collection policy can impact its ability to collect accounts receivable in a timely manner, but if the policy is too strict, it may lead to lost sales and reduced profits. Finding the right balance is important for maintaining cash flow and profitability.

Question 20

Suppose a firm changes its credit policy from 2/10 net 30 to 3/10 net 30.The change is meant to meet competition, so no increase in sales is expected.The average accounts receivable balance will probably decline as a result of this change.

Accepted Answer

By offering a higher discount percentage, customers are more likely to pay their bills sooner, resulting in a lower average accounts receivable balance.

Quiz 17: Supply Chains and Working Capital Management

Because money has time value, a cash sale is always more profitable than a credit sale.

Famous Farm's payables deferral period (PDP) is 50 days (on a 365-day basis) , accounts payable are $100 million, and its balance sheet shows inventory of $125 million.What is the inventory turnover ratio?

Which of the following is NOT commonly regarded as being a credit policy variable?

Which of the following statements is CORRECT?

If a firm's suppliers stop offering cash discounts, then its use of trade credit is more likely to increase than to decrease, other things held constant.

Trade credit can be separated into two components: free trade credit, which is credit received after the discount period ends, and costly trade credit, which is the cost of discounts not taken.

For a zero-growth firm, it is possible to increase the percentage of sales that are made on credit and still keep accounts receivable at their current level, provided the firm can shorten the length of its collection period sufficiently.

If a firm sells on terms of 2/10 net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the 30-day credit period tells us that the credit department is functioning efficiently and there are no past-due accounts.

Not taking cash discounts is costly, and as a result, firms that do not take them are usually those that are performing poorly and have inadequate cash balances.

Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.

Krackle Korn Inc.had credit sales of $3,500,000 last year and its days sales outstanding was DSO = 35 days.What was its average receivables balance, based on a 365-day year?

Which of the following statements is CORRECT?

If a firm busy on terms of 2/10 net 30, it should pay as early as possible during the discount period.

Which of the following statements is CORRECT?

The four primary elements in a firm's credit policy are (1) credit standards, (2) cash discounts offered, (3) credit period, and (4) collection policy.

As a rule, managers should try to always use the free component of trade credit but should use the costly component only if the cost of this credit is lower than the cost of credit from other sources.

Changes in a firm's collection policy can affect sales, working capital, and profits.

A firm's collection policy, i.e., the procedures it follows to collect accounts receivable, plays an important role in keeping its average collection period short, although too strict a collection policy can reduce profits due to lost sales.

Suppose a firm changes its credit policy from 2/10 net 30 to 3/10 net 30.The change is meant to meet competition, so no increase in sales is expected.The average accounts receivable balance will probably decline as a result of this change.