Question 1

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

The profitability of a firm that employs an aggressive current asset financing policy is not directly related to the shape of the yield curve. The profitability depends on the cost of financing and the return on investment, among other factors. A change in the yield curve may affect these factors, but it is not a direct or predictable relationship.

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 expected to grow at a steady rate of 10% annually, the accounts receivable balance will also grow in proportion to the credit sales. Therefore, Dimon's accounts receivable balance cannot remain constant at the current level.

Question 3

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's cash receipts are concentrated at the beginning of each month, the peak borrowing needs may be overstated if the firm assumes uniform cash receipts and payments throughout the month. This is because the firm may have more cash available at the beginning of the month than it initially projected, and it may not need to borrow as much as it thought it did.

Question 4

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 payment to suppliers beyond the agreed-upon terms. This can have a real financial cost to the firm as it may disrupt cash flow and potentially harm supplier relationships. Though periodic payment may mitigate some of the harm, it does not completely eliminate the financial cost of stretching accounts payable.

Question 5

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

Though separate, the cash budget and capital budget are interdependent and often developed together to ensure the availability of funds for capital expenditures.

Question 6

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 7

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

While depreciation is a non-cash charge and does not directly affect the cash budget, it impacts the cash budget indirectly through its effect on taxes. Higher depreciation reduces taxable income, which in turn reduces taxes paid, thereby affecting the cash outflows in the cash budget.

Question 8

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

Accepted Answer

A DSO of 28 days, while within the 30-day credit period, does not necessarily indicate the absence of past-due accounts or that the credit department is functioning efficiently. It simply means that, on average, receivables are collected in 28 days. Some accounts could still be paying early to take advantage of discounts, while others might be past due.

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 many sales are made on credit, whereas the payables-to-sales ratio measures how many purchases are made on credit. These two ratios are not directly related and can differ depending on the payment terms negotiated by the firm with its customers and suppliers. It is possible for a firm to have a high receivables-to-sales ratio but a low payables-to-sales ratio, or vice versa.

Question 10

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 if the supplier lengthens the credit period, it means the customer will take longer to pay, therefore shortening the customer's cash conversion cycle. However, this also means that the supplier will have to wait longer to receive payment, which lengthens their own CCC.

Question 11

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 cover its short-term liabilities and operational costs.

Question 12

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

If a firm can synchronize its receipts and disbursements, it can reduce the need for a large cash balance to cover imbalances between inflows and outflows. This can lead to a decrease in the opportunity cost of holding cash and an increase in profitability.

Question 13

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

The statement accurately describes the purpose and factors included in the cash conversion cycle, and correctly identifies that a shorter CCC is generally a sign of more effective working capital management.

Question 14

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 can shorten the length of its collection period, it can collect payment from credit sales more quickly, which would enable it to increase the percentage of sales made on credit without increasing accounts receivable. As a result, the firm would be able to maintain its current level of accounts receivable even with a higher percentage of credit sales.

Question 15

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, short-term assets are financed with short-term debt, and long-term assets are financed with long-term debt, rather than varying the mix based on interest rate levels.

Question 16

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 business can invest the receivables for a higher return.

Question 17

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 throughout the month but actually experiences concentrated payments at the beginning, it will likely underestimate its peak borrowing needs, as it will need more cash upfront to cover these early-month payments.

Question 18

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

This statement is true as a firm that relies on short-term credit for financing their current assets would have to renew their credit frequently and would be vulnerable to sudden increases in interest rates. In contrast, a firm that uses long-term capital for financing would have a more stable financing structure and would be less exposed to interest rate fluctuations.

Question 19

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 affect both the income statement and the balance sheet. The cost of not taking discounts can increase the firm's expenses, affecting net income. Additionally, delaying payment can increase accounts payable, affecting the balance sheet's liabilities section.

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 help to keep its average collection period short by encouraging prompt payment of accounts receivable. However, if the policy is too strict and causes customers to refuse to do business with the firm, this can lead to lost sales and reduced profits. Therefore, a balance must be struck between effective collections and maintaining good customer relationships.

Quiz 16: Working Capital Management