Question 1

The cash budget and the capital budget are planned separately, and although they are both important to the firm, they are independent of each other.

Accepted Answer

The cash budget and the capital budget are interrelated; the capital budget affects the cash budget as capital expenditures impact cash flow.

Question 2

A line of credit can be either a formal or informal agreement between borrower and bank regarding the maximum amount of credit the bank will extend to the borrower subject to certain conditions.

Accepted Answer

This statement accurately describes what a line of credit is. It can either be a formal agreement or a more informal arrangement, but it always sets a maximum credit limit that the borrower can access as needed. The specific terms and conditions of the line of credit will vary depending on the agreement, but typically involve factors such as interest rates, repayment schedules, and penalties for late payment or exceeding the credit limit.

Question 3

Synchronization of cash flows is an important cash management technique and effective synchronization can actually increase a firm's profitability.

Accepted Answer

By synchronizing cash inflows and outflows, a firm can optimize the utilization of its financial resources, reduce the need for external financing and improve its earnings potential. As a result, effective cash flow synchronization can increase a firm's profitability.

Question 4

The maturity of most bank loans is short-term. Bank to business loans are frequently 90-day notes which are often rolled over, or renewed, at the end of their maturity.

Accepted Answer

Most bank loans, especially business loans, have a short-term maturity, typically ranging from 30 days to one year. 90-day notes are common, and they can often be rolled over or renewed at the end of their term.

Question 5

A lockbox plan is one method of speeding up the check-clearing process for customer payments and decreasing the firm's net float position.

Accepted Answer

The answer of A lockbox plan is one method of...

Question 6

Under a revolving credit agreement the risk to the firm of being unable to obtain funds when needed is lower than with a line of credit.

Accepted Answer

A revolving credit agreement is a more formal and committed arrangement than a line of credit, often involving a commitment fee, which reduces the risk of funds being unavailable when needed.

Question 7

Generally, the longer the normal inventory holding period of a customer the longer the credit period. One effect of extending the credit period to match the customer's merchandise holding period is to increase the deferrables period which actually serves to shorten the customer's cash conversion cycle.

Accepted Answer

By extending the credit period to match the customer's merchandise holding period, the deferrables period is increased. This means that the time period between when the inventory is purchased and when the payment is due is longer, which shortens the customer's cash conversion cycle.

Question 8

Changes in a firm's collection policy can affect sales, working capital and even additional funds needed.

Accepted Answer

Changes in the collection policy can affect the cash flow of a firm, which in turn can impact its ability to fund operations, invest in new projects or pay off debts on time. If a firm tightens its collection policy, it may lead to lower sales as customers may find it difficult to make timely payments. On the other hand, if a firm relaxes its collection policy, it may boost sales in the short term but increase the risk of bad debt and increase the need for additional funds to finance operations. Therefore, changes in the collection policy should be carefully evaluated to ensure that they align with the firm's overall financial goals and objectives.

Question 9

A firm has a daily average collection of checks equal to $250,000. It takes the firm approximately 4 days to convert the funds into usable cash. Assume (1) a lockbox system could be employed which would reduce the cash conversion procedure to 2 ½ days and (2) the firm could invest any additional cash received at 6 percent after taxes. The lockbox system would be a good buy if it costs only $23,000 annually.

Accepted Answer

The answer of A firm has a daily average collection...

Question 10

In managing a firm's accounts receivable it is possible to increase credit sales per day yet still keep accounts receivable fairly steady if the firm can shorten the length of its collection period.

Accepted Answer

By shortening the length of the collection period, the firm can collect payments more quickly and use those funds to extend credit to more customers without significantly increasing the total balance of accounts receivable. This can result in an increase in credit sales per day while still keeping accounts receivable fairly steady.

Question 11

Since depreciation is a non-cash charge it does not appear nor have an effect on the cash budget.

Accepted Answer

While depreciation is a non-cash charge, it does have an effect on the cash budget. Depreciation is deducted from revenues to calculate net income, and net income affects the cash balance by influencing taxes payable, retained earnings, and dividends paid. In addition, depreciation might impact capital expenditures if the company uses it to calculate the depreciation expenses in the future.

Question 12

If your firm's DSO or aging schedule deteriorates from the first quarter of the year to the second quarter, this is a clear indication that your firm's credit policy has weakened.

Accepted Answer

A deterioration in DSO or aging schedule could indicate that customers are taking longer to pay, but it doesn't necessarily mean the credit policy has weakened; it could be due to other factors like economic conditions or changes in customer behavior.

Question 13

A firm which makes 90 percent of its sales on credit and 10 percent for cash is currently growing at a rate of 10 percent annually. If the firm maintains stable growth it will also be able to maintain its accounts receivable at its current level, since the 10 percent cash sales can be used to manage the 10 percent growth rate.

Accepted Answer

A firm growing at 10% annually will likely see an increase in accounts receivable if 90% of sales are on credit, as the cash sales alone are insufficient to cover the growth in credit sales.

Question 14

If a firm's terms are 2/10, net 30 days, and its DSO is 28 days, we can be certain that the credit department is functioning efficiently and the percentage of past due accounts is minimal.

Accepted Answer

The DSO (Days Sales Outstanding) indicates the average amount of time it takes for customers to pay their invoices. A DSO of 28 days means that on average, customers are taking 28 days to pay their bills, which is longer than the 30-day payment terms. This suggests that there may be some past due accounts or slower payment behavior, which could indicate inefficiencies in the credit department or credit policies. The 2/10 discount offered for early payment is also not being taken advantage of, which could suggest a lack of incentive or communication to customers about the discount.

Question 15

A promissory note is the document signed when a bank loan is executed and it specifies financial aspects of the loan. The separate indenture note will specify items such as collateral and other terms and conditions.

Accepted Answer

A promissory note is a legal document that includes the borrower's promise to repay the loan, the amount of the loan, the interest rate, and the repayment terms. An indenture note, on the other hand, is a separate document that outlines the terms and conditions of the loan, including any collateral that is pledged as security for the loan.

Question 16

Collections float offsets disbursement float. If a firm's collections float is greater than its disbursement float then a firm is said to operate with positive net float.

Accepted Answer

The answer of Collections float offsets disbursement float. If a...

Question 17

The target cash balance is set optimally such that it need not be adjusted for seasonal patterns and unanticipated fluctuations although it is changed to reflect long-term changes in the firm's operations.

Accepted Answer

The target cash balance should be adjusted for seasonal patterns and unanticipated fluctuations to ensure liquidity, even if it is primarily set for long-term operational changes.

Question 18

If a firm's sales and those of its customers are closely correlated with economic conditions, it is certainly possible for a firm's total investment in accounts receivable to decrease while its days sales outstanding increases.

Accepted Answer

If economic conditions worsen, both the firm's sales and the sales of its customers may decrease. This could result in the firm collecting payments slower and the days sales outstanding increasing, even if they decrease their investment in accounts receivable.

Question 19

In part because money has time value, cash sales are always more profitable and more valuable than credit sales.

Accepted Answer

Cash sales are not always more profitable than credit sales, as the profitability depends on various factors such as interest rates, customer relationships, and business strategy.

Question 20

A firm's collection policy and the procedures it follows to collect accounts receivable play an important role in keeping its deferrables period short, although too strict a collection policy can result in outright losses due to non-payment.

Accepted Answer

A too strict collection policy can lead to losses due to lost sales, not non-payment. Non-payment losses occur when customers do not pay, which is more likely with a lenient policy.

Quiz 21: Working Capital Management