Question 1

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

If a zero-growth firm increases its percentage of sales made on credit and shortens its collection period, it can maintain its current level of accounts receivable. This is because the firm would be collecting the money owed to them more quickly and efficiently, offsetting the increase in sales made on credit.

Question 2

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 a firm assumes that cash receipts and payments occur uniformly over the month, it may underestimate the cash balance necessary to cover peak borrowing needs when receipts are actually concentrated at the beginning of the month. This can lead to unexpected cash shortages and the need for additional borrowing.

Question 3

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 4

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 expected to grow at a steady rate of 10%, then the accounts receivable balance should also increase by 10% to support the increased credit sales. Therefore, the assumption that the accounts receivable balance will remain constant is not valid, and the answer is false.

Question 5

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 6

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 can have a real financial cost to a firm, as it can reduce their cash flow and ability to pay bills on time. It also may indicate potential cash flow problems or financial instability for the customer, which can pose a risk to the firm's future business relationship with them.

Question 7

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 8

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 9

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 target cash balance may need to be adjusted for seasonal patterns or unforeseen events that affect cash inflows or outflows.

Question 10

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 11

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 represents the amount of sales that are still owed by customers to the firm, while the payables-to-sales ratio represents the amount of purchases that are still owed by the firm to suppliers. These ratios may not necessarily be directly correlated, as a firm may have a high level of receivables due to slow-paying customers, but still have a low level of payables due to negotiated payment terms with suppliers. Similarly, a firm may have a high level of payables due to extended payment terms, but still have a low level of receivables due to diligent collection efforts.

Question 12

The longer its customers normally hold inventory, the longer the credit period supplier firms normally offer. Still, suppliers have some flexibility in the credit terms they offer. If a supplier lengthens the credit period offered, this will shorten the customer's cash conversion cycle but lengthen the supplier firm's own CCC.

Accepted Answer

The statement is true. If a supplier lengthens the credit period offered, it allows the customer to hold inventory longer and thus shortens their cash conversion cycle. However, it also lengthens the supplier's own cash conversion cycle as they are waiting longer to receive payment for their goods.

Question 13

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 14

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 15

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

A revolving credit agreement is typically accompanied by a commitment fee, which compensates the bank for the commitment to extend funds that may or may not be used by the borrower. This fee is often calculated as a percentage of the unused balance of the committed funds.

Question 16

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 17

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

Synchronization of cash flows helps a firm to efficiently manage its cash balance by aligning the timing of inflows and outflows, which reduces the need for excessive cash reserves and increases profitability.

Question 18

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 capital budget are interrelated and impact each other. The capital budget involves capital expenditures, which affect the cash flow, and the cash budget helps to determine the availability of funds for capital expenditures. Therefore, they need to be developed together to ensure the financial stability and sustainability of the organization.

Question 19

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 does play an important role in keeping its average collection period short, but if the policy is too strict, it can lead to lost sales and reduced profits. Therefore, a balance between being firm in collecting receivables and maintaining good customer relationships is essential.

Question 20

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 correctly describes the purpose and impact of the cash conversion cycle on working capital management.

Quiz 15: Working Capital Management