Question 1

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, the firm may need to turn to trade credit to maintain its inventory or production levels, which could result in an increase in the use of trade credit.

Question 2

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 3

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. Therefore, the formula is:
Net working capital = Current assets - Current liabilities

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

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 6

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, as some components of current assets do not shrink to zero even during seasonal or cyclical lows.

Question 7

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 requires coordination among sales, purchasing, and production personnel to ensure that inventory levels are appropriate for meeting customer demand while minimizing costs. Sales forecasts, production schedules, and purchasing plans all affect inventory levels, and communication and collaboration among these departments is crucial for efficient and effective inventory management.

Question 8

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.

Question 9

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

Accepted Answer

The formula for calculating average accounts receivables balance is (credit sales / 365) x days sales outstanding. Therefore, both the volume of credit sales and the days sales outstanding play a role in determining the average accounts receivables balance.

Question 10

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 11

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 involves using long-term securities to finance permanent current assets and some seasonal current assets, rather than relying heavily on short-term financing. This reduces the risk of liquidity problems and allows for more stable financing in the long-term.

Question 12

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 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 providing customers with a lockbox address for payments, the firm can receive and process payments quicker, reducing the time and resources spent on manual processing and depositing.

Question 14

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

The formula for net operating working capital is current assets minus non-interest-bearing current liabilities (such as accounts payable and accrued expenses). The formula for the current ratio is current assets divided by current liabilities, while the formula for the quick ratio is (current assets minus inventory) divided by current liabilities. Therefore, net operating working capital cannot be equal to the current ratio minus the quick ratio.

Question 15

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

Accepted Answer

A firm's collection policy determines how quickly it collects payment from its customers. If a firm tightens its collection policy, it may reduce sales as customers may switch to competitors who offer more lenient payment terms. However, a tighter collection policy can also improve working capital and cash flow, which in turn can lead to greater profits. Conversely, a more lenient collection policy may increase sales but also increase the risk of bad debts, which can negatively impact working capital and profits. Therefore, changes in a firm's collection policy can have significant effects on sales, working capital, and profits.

Question 16

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

Accepted Answer

The text discusses three alternative current asset investment policies that differ in terms of the size of current asset holdings.

Question 17

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

A reduction in DSO means that the firm is collecting cash from its customers quicker, which would shorten its CCC and improve its cash position.

Question 18

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

Accepted Answer

An increase in any current asset does not necessarily have to be accompanied by an increase in a current liability. For example, an increase in cash (a current asset) could be due to an increase in sales (an increase in revenue, a non-current liability such as long-term loans or bonds) rather than an increase in accounts payable (a current liability).

Question 19

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

This statement is true as it suggests that managers should prioritize using free trade credit and only rely on costly trade credit if it is still a more affordable option compared to other sources of credit.

Question 20

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

The use of short-term debt exposes a company to the risks of interest rate fluctuations and the possibility of being unable to rollover or refinance the debt at favorable rates, leading to liquidity problems. Therefore, it is considered to be an aggressive strategy.

Quiz 15: Working Capital