Question 1

A revolving credit agreement is a formal line of credit. The firm must generally pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.

Accepted Answer

This is true. Revolving credit agreements are like credit cards in that they offer a line of credit that can be used and repaid repeatedly, subject to certain terms and limits. However, the firm typically pays a commitment fee on the unused portion of the revolving credit line as compensation to the lender for making the funds available.

Question 2

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 tell us that the credit department is functioning efficiently and there are no past due accounts.

Accepted Answer

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

Question 3

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

This is because if the firm can collect payments faster, it can offset the increased percentage of sales made on credit and maintain the same level of accounts receivable.

Question 4

A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality receipts are concentrated at the beginning of each month.

Accepted Answer

If cash receipts are concentrated at the beginning of the month, a firm's peak borrowing needs would occur earlier in the month than if they were uniformly spread out. This would cause the firm's peak borrowing needs to be overstated if its monthly cash budget assumes uniform cash receipts and payments throughout the month.

Question 5

A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality payments are concentrated at the beginning of each month.

Accepted Answer

If a firm assumes cash flows occur uniformly but actually experiences concentrated payments at the beginning of the month, its peak borrowing needs may be understated, not overstated, because it might not account for the immediate cash outflow at the month's start.

Question 6

The target cash balance is typically (and logically) set so that it does not need to be adjusted for either seasonal patterns or unanticipated random fluctuations.

Accepted Answer

The answer of The target cash balance is typically (and...

Question 7

If a profitable firm finds that it simply must "stretch" its accounts payable, then this suggests that it is undercapitalized, i.e., that it needs more working capital to support its operations.

Accepted Answer

Stretching accounts payable, even for a profitable firm, indicates a cash flow issue, suggesting the firm does not have enough working capital to comfortably meet its short-term obligations, thus pointing to undercapitalization.

Question 8

Synchronization of cash flows is an important cash management technique, as proper synchronization can reduce the required cash balance and increase a firm's profitability.

Accepted Answer

Synchronizing cash flows means aligning the inflows and outflows of cash to minimize idle cash balances and maximize the use of available funds. This can help reduce the required cash balance and increase profitability by allowing the firm to earn interest on excess cash or invest it elsewhere.

Question 9

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 how quickly a firm collects payment from its customers, while the payables-to-sales ratio measures how quickly a firm pays its suppliers. The two ratios are not directly related and can vary independently depending on a firm's payment and collection policies.

Question 10

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 time period of the credit, and the opportunity cost of having cash now versus later. A credit sale could potentially be more profitable if the terms of the credit include a favorable interest rate or if the deferred payments allow the seller to invest the receivables in high-return opportunities.

Question 11

The prime rate charged by big money center banks at any one time is likely to vary greatly (for example, as much as 2 to 4 percentage points) across banks due to banks' ability to differentiate themselves and because different banks operate in different parts of the country.

Accepted Answer

The answer of The prime rate charged by big money...

Question 12

Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget. Thus, if the depreciation charge for the coming year doubled or halved, this would have no effect on the cash budget.

Accepted Answer

The answer of Since depreciation is a non-cash charge, it...

Question 13

The cash conversion cycle (CCC) combines three factors: The inventory conversion period, the receivables collection period, and the payables deferral period, and its purpose is to show how long a firm must finance its working capital. Other things held constant, the shorter the CCC, the more effective the firm's working capital management.

Accepted Answer

The statement accurately describes the purpose and relationship of the cash conversion cycle (CCC) to a firm's working capital management.

Question 14

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 sales are growing at a steady rate of 10% annually, then the accounts receivable balance will also increase by 10% annually, assuming the credit terms remain unchanged. Therefore, Dimon's accounts receivable balance is likely to increase over time, rather than remain constant.

Question 15

If a firm switched from taking trade credit discounts to paying on the net due date, this might cost the firm some money, but such a policy would probably have only a negligible effect on the income statement and no effect whatever on the balance sheet.

Accepted Answer

Switching from taking trade credit discounts to paying on the net due date can significantly impact both the income statement and the balance sheet. It can increase the cost of goods sold (due to lost discounts), affecting net income, and alter current liabilities and potentially cash balances on the balance sheet.

Question 16

If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it does not represent a real financial cost to your firm as long as the customer periodically pays off its entire balance.

Accepted Answer

Stretching accounts payable means delaying payments to suppliers or vendors in order to hold onto cash for longer. This can have real financial costs for the suppliers or vendors, as they may have to pay interest on their own debts or face cash flow problems. Therefore, if a customer is consistently stretching their accounts payable, it could have a negative impact on your firm's profitability and financial health.

Question 17

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

Accepted Answer

Changing the firm's collection policy can affect the cash flow from sales, which impacts working capital, and ultimately has an effect on the profitability of the business.

Question 18

On average, a firm collects checks totaling $250,000 per day. It takes the firm approximately 4 days from the day the checks were mailed until they result in usable cash for the firm. Assume that (1) a lockbox system could be employed which would reduce the cash conversion procedure to 2 1/2 days and (2) the firm could invest any additional cash generated at 6% after taxes. The lockbox system would be a good buy if it costs $25,000 annually.

Accepted Answer

The answer of On average, a firm collects checks totaling...

Question 19

The cash budget and the capital budget are handled separately, and although they are both important, they are developed completely independently of one another.

Accepted Answer

The cash budget and the capital budget are interrelated and must be developed in conjunction with one another. The capital budget outlines the expected expenditures for long-term projects, which will impact the cash budget in future periods. The cash budget, in turn, provides the means to finance these long-term projects outlined in the capital budget.

Question 20

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 affect the average collection period, and a too strict policy can lead to lost sales and reduced profits.

Quiz 16: Working Capital Management