Question 1

The average accounts receivables balance is a function of both the volume of credit sales and the days sales outstanding.

Accepted Answer

Accounts receivables balance is calculated by multiplying the volume of credit sales by the number of days it takes to collect payment (days sales outstanding). Therefore, it is a function of both factors.

Question 2

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

Managers should aim to use the free component of trade credit as much as possible as it does not incur any additional cost. However, if they need to use the costly component, they should only do so if the cost is lower than other sources of credit.

Question 3

If a firm's suppliers stop offering 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 discounts, a firm may need to increase its use of trade credit to maintain its inventory or operations, as it may no longer be able to rely on the discounts to offset the cost of financing.

Question 4

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

Accepted Answer

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

Question 5

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

Accepted Answer

Changes in the collection policy can impact sales as customers may choose not to purchase from the firm if the collection terms are too strict. It can also impact working capital as the collection process affects the company's ability to receive cash from its customers. Finally, changes in the collection policy can impact profitability, as a more aggressive collection policy could result in faster receipt of cash, while a less aggressive policy may result in slower receipt of cash.

Question 6

If a firm buys on terms of 2/10, net 30, it should pay as early as possible during the discount period to lower its cost of trade credit.

Accepted Answer

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

Question 7

A conservative financing approach to working capital will result in permanent current assets and some seasonal current assets being financed using long-term securities.

Accepted Answer

A conservative financing approach to working capital aims to minimize the risk of short-term financing by using long-term securities to finance permanent current assets and some seasonal current assets. This approach typically results in a lower risk of default but also may limit the ability of the company to take advantage of short-term opportunities or changes in the market.

Question 8

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. Firms that are performing poorly or have inadequate cash balances may not be able to take advantage of these discounts, thus incurring higher expenses.

Question 9

Inventory management is largely self-contained in the sense that very little coordination among the sales, purchasing, and production personnel is required for successful inventory management.

Accepted Answer

Inventory management involves coordinating sales forecasts, production schedules, and purchasing plans to ensure that the right amount of inventory is available at the right time. It requires collaboration and communication among sales, purchasing, and production teams to successfully manage inventory levels.

Question 10

Net operating working capital, defined as current assets minus the difference between current liabilities and notes payable, is equal to the current ratio minus the quick ratio.

Accepted Answer

Net operating working capital is equal to current assets minus current liabilities. The quick ratio is calculated by subtracting inventory from current assets and dividing the result by current liabilities. The current ratio is calculated by dividing current assets by current liabilities. Therefore, the statement is false.

Question 11

The three alternative current asset investment policies discussed in the text differ regarding the size of current asset holdings.

Accepted Answer

The three alternative current asset investment policies discussed in the text are aggressive, moderate, and conservative, and they differ in the level of current asset holdings, with aggressive policy holding the lowest level and conservative policy holding the highest level of current assets.

Question 12

The concept of permanent current assets reflects the fact that some components of current assets do not shrink to zero even when a business is at its seasonal or cyclical low. Thus, permanent current assets represent a minimum level of current assets that must be financed.

Accepted Answer

The statement is true. Permanent current assets refer to the minimum level of current assets that a business must finance even at the seasonal or cyclical low, as some components of current assets do not shrink to zero.

Question 13

Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers.

Accepted Answer

By having a lockbox arrangement, customers can send their payments directly to a designated post office box or bank lockbox, which speeds up the processing and collection of payments by the firm.

Question 14

If a firm takes actions that reduce its days sales outstanding (DSO), then, other things held constant, this will lengthen its cash conversion cycle (CCC) and cause a deterioration in its cash position.

Accepted Answer

The statement is incorrect. A reduction in DSO would actually shorten the cash conversion cycle and improve a firm's cash position.

Question 15

Shorter-term cash budgets--say a daily cash budget for the next month--are generally used for actual cash control while longer-term cash budgets--say monthly cash budgets for the next year--are generally used for planning purposes.

Accepted Answer

Shorter-term cash budgets are used for actual cash control, while longer-term cash budgets are used for planning purposes. This is because shorter-term budgets can account for any immediate cash needs, while longer-term budgets can help businesses plan for future expenses and revenue streams.

Question 16

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 can be separated into two components: free trade credit, which is credit received during the discount period without incurring any cost, and costly trade credit, which refers to the cost associated with not taking the discounts and extending payment beyond the discount period.

Question 17

Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive current asset financing strategy because of the inherent risks of using short-term financing.

Accepted Answer

Using heavy short-term debt can be risky because short-term rates can fluctuate quickly and unexpectedly, leading to increased borrowing costs and potential liquidity issues if the debt cannot be rolled over or paid off when due. Therefore, it is considered an aggressive strategy compared to using more long-term financing.

Question 18

Other things held constant, if a firm "stretches" (i.e., delays paying) its accounts payable, this will lengthen its cash conversion cycle (CCC).

Accepted Answer

Stretching accounts payable (delaying payment to suppliers) actually reduces the cash conversion cycle (CCC) because it increases the amount of time cash remains with the firm before it needs to pay its suppliers, thus shortening the cycle.

Question 19

An increase in any current asset must be accompanied by an equal increase in some current liability.

Accepted Answer

An increase in a current asset can be financed by an increase in current liabilities, but it can also be financed by an increase in long-term liabilities, equity, or cash. Therefore, an increase in any current asset does not have to be accompanied by an equal increase in some current liability.

Question 20

Net working capital is defined as current assets divided by current liabilities.

Accepted Answer

Net working capital is defined as current assets minus current liabilities, not divided by.

Quiz 17: Working Capital