Question 1

One of the advantages of short-term debt financing is that firms can obtain short-term credit more quickly than long-term credit.

Accepted Answer

Short-term debt financing typically involves obtaining credit that is due within a year or less, whereas long-term debt financing involves obtaining credit that is due over several years or more. Due to the shorter duration of the loan, it is often easier and quicker for firms to obtain short-term credit compared to long-term credit.

Question 2

Shorter-term cash budgets, in general, are used for actual cash control while longer-term cash budgets are used for planning purposes.

Accepted Answer

Shorter-term cash budgets are typically used for tracking and controlling actual cash inflows and outflows on a day-to-day or week-to-week basis, while longer-term cash budgets are useful for forecasting and planning future cash needs, opportunities, and potential risks.

Question 3

If a firm takes actions that reduce its DSO, then, other things held constant, this will lengthen its CCC.

Accepted Answer

A reduction in DSO (days sales outstanding) means that a firm is collecting its accounts receivables faster, which leads to a decrease in the cash conversion cycle (CCC) since it can convert its sales into cash quicker. Therefore, if DSO is reduced, holding all other factors constant, the CCC will be shortened, not lengthened.

Question 4

A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption of uniform daily cash receipts and disbursements, but actual receipts are concentrated at the beginning of each month.

Accepted Answer

If actual receipts are concentrated at the beginning of the month, it means the firm will have a surplus of cash at the start of the month, which can be used to cover expenses for the rest of the month. If the monthly cash budget assumes uniform daily cash receipts and disbursements, it will underestimate the surplus and overestimate the borrowing needs.

Question 5

Determining a firm's optimal investment in net operating working capital and how that investment is financed are elements of working capital policy.

Accepted Answer

Working capital policy involves determining the optimal level of investment in net operating working capital and deciding on the appropriate financing mix to support that investment.

Question 6

A conservative financing approach to working capital will result in most of the permanent net operating working capital being financed by long-term securities.

Accepted Answer

A conservative approach to working capital management involves financing most of the permanent net operating working capital with long-term securities, such as equity or long-term debt, in order to reduce the risk of short-term funding shortages. This approach prioritizes stability and liquidity over maximizing short-term returns.

Question 7

Short-term financing is riskier than long-term financing since, during periods of tight credit, the firm may not be able to rollover (renew) its debt. This is especially true if the funds are used to finance long-term rather than short-term assets.

Accepted Answer

Short-term financing is generally riskier than long-term financing as it may not be possible for a company to roll over or renew its debt during periods of tight credit. This risk is compounded if the funds obtained through short-term financing are used to finance long-term assets.

Question 8

An increase in the holding of marketable securities must be accompanied by a corresponding increase in the net operating working capital.

Accepted Answer

An increase in the holding of marketable securities is typically considered an investment activity, not an operating activity, and therefore does not directly affect net operating working capital, which is calculated based on operating current assets and liabilities.

Question 9

Net working capital is defined as current assets minus current liabilities.

Accepted Answer

Net working capital is the difference between a company's current assets (such as cash, accounts receivable, and inventory) and its current liabilities (such as accounts payable and short-term loans). Therefore, the statement is true.

Question 10

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 operating working capital. Other things held constant, the shorter the CCC, the more effective the firm's working capital management.

Accepted Answer

The statement is true.

Question 11

Gross working capital simply refers to current assets used in operations.

Accepted Answer

Gross working capital includes all current assets used in daily operations, such as cash, inventory, accounts receivable, and prepaid expenses.

Question 12

Offering trade credit discounts is costly and, as a result, firms that offer trade discounts are usually those that are performing poorly and need cash quickly.

Accepted Answer

This statement is false. Offering trade credit discounts can actually be a strategic move to incentivize customers to pay sooner, which can improve a company's cash flow and overall financial performance. Additionally, many successful companies offer trade discounts as a standard business practice.

Question 13

Minimizing cash holdings, inventories, or receivables, and maximizing payables or accruals are the aims of relaxed working capital policies.

Accepted Answer

The statement is incorrect. Relaxing working capital policies would mean an increase in cash holdings, inventories, and receivables, and a decrease in payables or accruals.

Question 14

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 15

Funds from short-term loans can generally be obtained faster than from long-term loans for two reasons: (1) when lenders consider long-term loans they must make a more thorough evaluation of the borrower's financial health, and (2) long-term loan agreements are more complex.

Accepted Answer

The statement is true as short-term loans typically involve smaller loan amounts and shorter repayment periods, making them less risky for lenders. Therefore, lenders can process and approve these loans more quickly without requiring as extensive of a financial evaluation or complex loan agreement.

Question 16

You receive some goods on April 1 with the following terms: 3/20, net 30, June 1 dating. This means that you will receive a 3% discount if the bill is paid on or before June 20 and also that the full amount must be paid 30 days after receipt of the goods.

Accepted Answer

The terms "3/20, net 30, June 1 dating" mean you receive a 3% discount if you pay within 20 days of June 1, and the full amount is due 30 days after June 1, not 30 days after receipt of the goods.

Question 17

Other things held constant, if a firm stretches its accounts payable, this will lengthen its CCC.

Accepted Answer

Stretching accounts payable increases the time a company takes to pay its suppliers, effectively reducing the cash conversion cycle (CCC) by decreasing the time cash is tied up in the working capital.

Question 18

Permanent net operating working capital reflects the fact that net operating working capital does not shrink to zero even when a business is at its seasonal or cyclical low. Thus, permanent net operating working capital represents a minimum level of net operating working capital that must be financed.

Accepted Answer

Permanent net operating working capital represents the minimum level of net operating working capital that must be financed even during seasonal or cyclical lows.

Question 19

The firm's total capital requirement grows over time with amounts including the base level of fixed assets and current assets. There exists seasonal variation around the trend showing the required temporary working capital.

Accepted Answer

This statement is true as a firm's capital requirement does increase over time due to the need to invest in fixed assets and current assets, and there may be seasonal variations in the necessary working capital.

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 working capital financing strategy because of the inherent risks of using short-term financing.

Accepted Answer

Short-term debt has the advantage of lower interest rates, but it also carries the risk of not being renewed or refinanced at a similar rate, leaving the company exposed to rising interest rates. This risk makes heavy use of short-term debt an aggressive strategy.

Quiz 17: Working Capital Management and Short-Term Financing