Question 1

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

Proper synchronization of cash flows can decrease the amount of cash needed to maintain operations, which ultimately increases profitability.

Question 2

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 by 10% annually, the accounts receivable balance would be expected to increase unless the company is able to collect its credit sales more quickly. Therefore, the statement that the accounts receivable balance will remain constant is likely false.

Question 3

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 relationship between receivables and payables is not necessarily direct. A high receivables-to-sales ratio indicates that a greater percentage of sales is tied up in outstanding customer payments, while a high payables-to-sales ratio indicates that a greater percentage of purchases is being financed through trade credit. These ratios may be influenced by a variety of factors, including the firm's industry, business model, and credit policies.

Question 4

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 5

The maturity matching, or "self-liquidating," approach to financing involves obtaining the funds for permanent current assets with a combination of long-term capital and short-term capital that varies depending on the level of interest rates. When short-term rates are relatively high, short-term assets will be financed with long-term debt to reduce costs.

Accepted Answer

The maturity matching, or "self-liquidating," approach to financing involves matching the maturity of the assets being financed with the maturity of the financing. So, permanent current assets would typically be financed with long-term capital, and short-term assets would be financed with short-term capital, regardless of the level of interest rates.

Question 6

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

This is because a longer credit period offered by the supplier would mean that the customer takes longer to pay for their inventory, which reduces the customer's cash conversion cycle. However, this also means that the supplier has to wait longer to receive payment from the customer, which would lengthen the supplier firm's own CCC.

Question 7

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 8

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 have an influence on each other. The cash budget determines the availability of cash for investments in the capital budget. Therefore, they are developed together and not independently of one another.

Question 9

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 the percentage of sales made on credit but shortens the collection period, it can receive payments faster and maintain the same level of accounts receivable. This is because the faster collection period compensates for the additional credit sales, resulting in the same level of outstanding receivables.

Question 10

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 11

If a firm has set up a revolving credit agreement with a bank, the risk to the firm of being unable to obtain funds when needed is lower than if it had an informal line of credit.

Accepted Answer

With a revolving credit agreement, the firm has a formal agreement with a bank to obtain a certain amount of funds, which reduces the risk of not being able to obtain funds when needed. An informal line of credit is not a formal agreement and may not guarantee availability of funds when needed.

Question 12

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, the firm's actual borrowing needs may be lower than what is estimated based on a uniform distribution of cash receipts and payments throughout the month. Therefore, peak borrowing needs will be overstated.

Question 13

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 14

A firm that follows an aggressive current asset financing approach uses primarily short-term credit and thus is more exposed to an unexpected increase in interest rates than is a firm that uses long-term capital and thus follows a conservative financing policy.

Accepted Answer

A firm that relies heavily on short-term credit will face a higher level of interest rate risk than a firm that has a more conservative financing policy that uses more long-term capital. Changes in interest rates will have a more direct and immediate impact on short-term credit than they will on long-term financing options. Therefore, the statement is true.

Question 15

A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the maximum amount of credit the bank will extend to the borrower during some future period, assuming the borrower maintains its financial strength.

Accepted Answer

This statement accurately describes what a line of credit is.

Question 16

Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e., after the fact) sense even though it is possible to match maturities on an ex ante (expected) basis.

Accepted Answer

This statement is true. Ex post maturity matching involves matching the actual lives of assets and liabilities, which is difficult due to uncertainty about the future. Ex ante maturity matching, on the other hand, involves matching based on expected future values and is easier to achieve.

Question 17

The relative profitability of a firm that employs an aggressive current asset financing policy will improve if the yield curve changes from upward sloping to downward sloping.

Accepted Answer

An aggressive current asset financing policy involves financing short-term assets with debt, which increases interest expense and decreases profitability in the long run. A downward-sloping yield curve indicates lower interest rates on long-term debt, which may make it more attractive for a firm to shift towards a more conservative financing policy that relies more on long-term debt. Therefore, a downward-sloping yield curve may actually decrease the relative profitability of a firm that employs an aggressive current asset financing policy.

Question 18

The cash conversion cycle (CCC) combines three factors: The inventory conversion period, the average 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

This statement is true as a shorter CCC indicates that a company is able to more efficiently manage its working capital and generate cash flow.

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 can indeed impact its average collection period, but if it's too strict, customers may choose not to do business with the firm, resulting in lost sales and reduced profits. Therefore, finding the right balance is essential.

Question 20

A promissory note is the document signed when a bank loan is executed, and it specifies financial aspects of the loan.

Accepted Answer

A promissory note is a legal document signed by a borrower that contains a written promise to pay back a specific amount of money to a lender on a predetermined date or on demand. It outlines the terms and conditions of the loan, including the interest rate, payment schedule, and any penalties for default. Banks typically use promissory notes to secure loans to individuals, businesses or other entities.

Quiz 16: Working Capital Management