Question 1

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 optimized for efficient operations and customer satisfaction. Sales personnel provide forecasts, purchasing personnel order materials or products, and production personnel use the inventory to manufacture products. Coordination is necessary to avoid stockouts, overstocking, or missed sales opportunities.

Question 2

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

False

Question 3

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 the conservative approach, the aggressive approach, and the maturity matching approach. These policies differ regarding the size of current asset holdings and how closely they are matched to the firm's current liabilities. The conservative approach advocates for larger current asset holdings, while the aggressive approach encourages smaller current asset holdings. The maturity matching approach seeks to match current assets and liabilities in terms of maturity and cash conversion cycle.

Question 4

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 as they help to identify cash inflows and outflows on a daily or weekly basis, allowing businesses to make necessary adjustments to their operations. Longer-term cash budgets are used for planning purposes as they provide a bigger picture of the organization's financial situation, allowing them to plan for future investments or expenses.

Question 5

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 6

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. Trade credit can have both a free component (not charging interest) and a costly component (charging interest or fees). It is always best for a manager to use the free component when available, but if they need to use the costly component, they should only do so if the cost is lower than other available sources of credit.

Question 7

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 8

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 financing permanent current assets and a portion of seasonal current assets using long-term securities such as bonds or stock instead of short-term debt. This approach ensures the company has stable and secure funding sources for its working capital needs.

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 average accounts receivables balance is calculated by multiplying the volume of credit sales by the days sales outstanding. Therefore, it is dependent on both factors.

Question 10

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 11

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 funded by a variety of sources such as equity and long-term liabilities, not necessarily only by an increase in current liabilities.

Question 12

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 statement is true. While short-term interest rates have historically been lower than long-term rates, relying heavily on short-term financing can be risky, as short-term debt must be constantly refinanced and can become more expensive during times of economic uncertainty.

Question 13

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

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

Question 14

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 will receive payment from customers. If the policy is too strict, sales may decrease as customers may choose to buy from competitors who offer more lenient payment terms. On the other hand, if the policy is too lax, the firm may run into cash flow issues which can impact working capital and profits. Therefore, changes in a firm's collection policy can have a significant impact on its sales, working capital, and profits.

Question 15

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.

Question 16

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 a measure of liquidity that only includes the most liquid current assets, while the current ratio includes all current assets. Therefore, the equation given in the statement is incorrect.

Question 17

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

Accepted Answer

By setting up a lockbox arrangement, a firm can allow its customers to send their payments directly to a designated lockbox address rather than sending payments to the firm's physical location, which can help to speed up the payment collection process. The lockbox provider is responsible for collecting the payments, depositing them into the firm's bank account, and providing timely updates on payment receipts to the firm.

Question 18

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 accurately describes the concept of permanent current assets. They represent a base level of current assets that a business must always have, regardless of fluctuations in sales or seasonal/cyclical patterns.

Question 19

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 extend their accounts payable periods and use more trade credit to finance their purchases.

Question 20

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 more quickly from customers, which would shorten its CCC and improve its cash position.

Quiz 16: Working Capital