Question 1

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 2

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 the firm can shorten the length of its collection period, it can collect outstanding payments faster and therefore maintain the same level of accounts receivable even with an increase in sales made on credit.

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 receivables-to-sales ratio and payables-to-sales ratio are independent of each other. A high receivables-to-sales ratio indicates that the firm is extending more credit to customers, while a high payables-to-sales ratio indicates that the firm is delaying payments to its suppliers. These two ratios can vary independently of each other.

Question 4

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 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

The cash budget and the capital budget are interconnected and must be considered together. The cash budget determines the availability of funds for the capital budget, while the capital budget outlines the planned expenditures for long-term investments which will impact the cash flow of the organization.

Question 6

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 7

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 typically involves a fee on the unused balance of the committed funds, known as a commitment fee. This fee compensates the bank for the commitment to extend funds when needed.

Question 8

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 9

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 length of its average collection period. A strict policy may result in lost sales and reduced profits, while a balanced policy can help maintain healthy cash flow.

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 both seasonal patterns (e.g. higher demand during holiday season) and unanticipated random fluctuations (e.g. unexpected expenses or revenue).

Question 11

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 12

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

Even though the 10% cash sales can support the 10% growth rate in the short term, eventually as sales continue to grow, the accounts receivable balance will also increase. Therefore, the statement that accounts receivable balance will remain constant is false.

Question 13

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 14

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

This statement is true. The cash conversion cycle is a measure of how long it takes for a company to convert its investments in inventory and accounts receivable into cash. The shorter the cycle, the better the company is at managing its working capital and generating cash flows.

Question 15

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

This statement is true. Synchronizing cash flows helps reduce the amount of cash a company needs to hold at any given time, which can increase profitability by reducing the opportunity cost of holding excess cash reserves.

Question 16

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 due date in order to free up cash for other uses. This can have a real financial cost to the supplier firm, as they may need to borrow funds or use their own cash reserves to cover their own expenses. While periodic payment may provide some relief, it may not fully compensate for the financial cost of delayed payment.

Question 17

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

If a firm switches from taking trade credit discounts to paying on the net due date, they will have to pay more for the goods and services they purchase. This will increase their expenses and, therefore, decrease their net income on their income statement. However, it will not have a direct impact on their balance sheet.

Question 18

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 bases its monthly cash budget on the assumption of uniform cash receipts and payments throughout the month, it will overstate its borrowing needs because it ignores the concentration of receipts at the beginning of the month. This means that the firm may borrow more than it needs, leading to unnecessary interest expenses.

Question 19

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 correctly describes the relationship between a customer's inventory holding period, supplier's credit period, and cash conversion cycle (CCC). If the supplier offers a longer credit period, it may benefit the customer by shortening their CCC, but it will also increase the supplier's own CCC. However, suppliers do have the flexibility to adjust their credit terms based on various factors such as the customer's creditworthiness, industry norms, and market conditions.

Question 20

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...

Quiz 15: Working Capital