Question 1

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 2

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 involves aligning inflows and outflows of cash in a way that minimizes the need for excess cash balances. This, in turn, can increase a firm's profitability by reducing the cost of holding excess cash and freeing up funds for more productive uses.

Question 3

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

If a customer is stretching its accounts payable, it means they are taking longer to pay their balance, which may cause cash flow issues for your firm. Additionally, the longer a customer stretches their accounts payable, the higher the risk of them defaulting on their payments. This can ultimately result in a financial cost for your firm if not managed effectively.

Question 4

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 often developed in conjunction with one another. The cash budget forecasts cash inflows and outflows, which are important inputs for the capital budget that outlines investments in long-term assets.

Question 5

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 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 statement is true. A longer credit period offered by the supplier means that the customer will take longer to pay, which shortens 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 cash conversion cycle. Therefore, suppliers have some flexibility in the credit terms they offer, but they need to carefully consider the impact on their own cash flow.

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

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

This statement is true. A revolving credit agreement is a formal line of credit, and most banks charge a fee for the unused balance of the committed funds as compensation for the commitment to extend those funds.

Question 10

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 unanticipated random fluctuations.

Question 11

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 12

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 13

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 accurately describes the purpose and significance of the cash conversion cycle.

Question 14

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 cash payments occur uniformly over the month, it may underestimate the amount of cash it needs at the beginning of the month when receipts are concentrated. This could lead to a peak borrowing need that is overstated.

Question 15

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 sufficiently, it can increase the percentage of sales made on credit without increasing the total amount of accounts receivable. This is because the firm can collect payments faster, enabling it to receive payments for new credit sales before previous ones become due, thus keeping the accounts receivable balance the same.

Question 16

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 17

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 and payables-to-sales ratio are not directly related. A firm may have a high receivables-to-sales ratio if it sells goods on credit and delays receiving payment from customers, but it may have a low payables-to-sales ratio if it pays its suppliers quickly or negotiates favorable payment terms. Conversely, a company may have a low receivables-to-sales ratio if it collects payments from customers quickly or mostly sells goods for cash, but it may have a high payables-to-sales ratio if it delays paying its suppliers or has a large amount of outstanding invoices.

Question 18

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 at a steady rate of 10% annually, the accounts receivable balance is likely to increase, unless the company improves its collections or extends less credit to customers. Therefore, Dimon's accounts receivable balance is unlikely to remain constant at the current level.

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 impact the average collection period, but if it is too strict, it may turn away customers and result in lost sales, which can harm profits.

Question 20

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...

Quiz 17: Working Capital