Question 1

The trade credit that a firm receives during the discount period is referred to as free trade credit.

Accepted Answer

Free trade credit refers to the credit a firm receives by taking advantage of the discount period offered by its supplier. It is considered "free" because the firm is not charged any additional fees or interest for this credit.

Question 2

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 3

Stretching accounts payable is a widely accepted and costless financing technique.

Accepted Answer

Stretching accounts payable, which means delaying payment to suppliers beyond the agreed terms, can damage supplier relationships, potentially lead to higher costs in the future, and may result in late payment fees or loss of favorable payment terms.

Question 4

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

Offering trade credit discounts can actually be a strategy used by financially stable firms to increase sales and build customer loyalty. While there are costs associated with offering trade discounts, such as the potential for bad debts, it is not an indicator that the firm is performing poorly.

Question 5

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 to monitor and control actual cash inflows and outflows on a daily or weekly basis, while longer-term cash budgets are often used for forecasting and strategic planning purposes, such as estimating future capital expenditures or evaluating the potential impact of changes in market conditions or business operations.

Question 6

As a rule,managers should try to always use the free component of trade credit but should use the costly component only if the cost of this credit is lower than the costs of credit from other sources.

Accepted Answer

This is because using the free component of trade credit does not involve any interest cost, whereas the costly component involves interest cost. Therefore, if the cost of the costly component is lower than the cost of credit from other sources, it may be beneficial to use it. However, if the cost is higher, it may not be a cost-effective option.

Question 7

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 financing usually comes with higher interest rates and the risk of having to refinance frequently, which can be challenging if market conditions change. Therefore, relying too heavily on short-term financing can be considered a more aggressive strategy.

Question 8

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 9

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 cash receipts are concentrated at the beginning of each month, the firm's peak borrowing needs may be lower than anticipated if it bases its cash budget on the assumption of uniform daily cash receipts and disbursements. This is because the firm may have periods of high cash balances due to large inflows of cash at the beginning of the month, which can help offset any cash shortages later in the month. Therefore, if the firm does not take into account the timing of its actual cash receipts and disbursements, it may overestimate its borrowing needs.

Question 10

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

Free trade credit is the credit received during the discount period without incurring any cost, while costly trade credit refers to the cost associated with not taking the discounts offered within the discount period.

Question 11

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 12

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 is the minimum level of net operating working capital that a business must have even during its seasonal or cyclical low period. Thus, it is a permanent requirement for the business and should be financed accordingly. Therefore, the statement is true.

Question 13

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 14

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

Accepted Answer

Minimizing cash holdings, inventories, or receivables, and maximizing payables or accruals are aims of aggressive working capital policies, not relaxed ones. Relaxed policies typically involve holding more current assets and being less aggressive about increasing current liabilities.

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 correctly explains the reasons why funds from short-term loans can be obtained faster than from long-term loans.

Question 16

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 financing approach will prioritize long-term financing for permanent net operating working capital. This helps to provide stability and reduce risk for the company's short-term liquidity needs.

Question 17

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 the total capital requirement of a firm includes both fixed assets and current assets. Additionally, there may be seasonal variations in the required temporary working capital.

Question 18

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

A firm's working capital policy includes decisions about how much to invest in net operating working capital and how that investment will be funded. This involves managing the levels of current assets and current liabilities to ensure that the firm has sufficient liquidity and operational efficiency. The optimal investment in net operating working capital depends on various factors such as the firm's size, growth prospects, industry, and competition. The financing of working capital can be done through various sources such as short-term loans, trade credit, or internal funds. Therefore, the statement is true.

Question 19

One of the effects of not taking trade credit discounts when offered is that the firm's use of accounts payable rises.

Accepted Answer

When a firm does not take trade credit discounts, it means they are not paying their accounts payable within the allowed timeframe, causing the balance of accounts payable to increase. This, in turn, decreases the firm's cash flow and could potentially harm their relationship with suppliers.

Question 20

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 typically involves debt that must be paid back within a year, while long-term financing lasts for several years or more. During times of tight credit, lenders may be hesitant to extend short-term credit to businesses, which can lead to difficulties renewing or obtaining new loans. In contrast, long-term financing usually involves a more stable repayment schedule and may be less affected by short-term fluctuations in credit conditions. Additionally, using short-term funds for long-term assets, such as fixed equipment or real estate, exposes the firm to greater risk since the loan may come due before the company has realized the full benefits of the investment.

Quiz 17: Working Capital Management and Short-Term Financing