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

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 3

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 4

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 correctly defines the cash conversion cycle and its purpose, and also correctly states that a shorter CCC indicates more effective working capital management.

Question 5

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

It is unlikely that the accounts receivable balance will remain constant at the current level with a 10% annual growth rate in sales. As sales increase, the accounts receivable balance would also be expected to increase, unless there is a significant improvement in collection policies or an increase in cash sales.

Question 6

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

While the cash budget and capital budget serve different purposes, they are related and need to be coordinated. The cash budget outlines the expected cash inflows and outflows for a given period, while the capital budget outlines the planned expenditures for long-term assets such as property, plant, and equipment. However, the capital budget can impact the cash budget, as it may require large expenditures that need to be factored into the cash inflows and outflows. Therefore, the two budgets should be developed together and coordinated to ensure the company has the necessary funds to meet its long-term goals while managing its cash flow.

Question 7

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 much of a company's sales are on credit and have not been collected yet, while the payables-to-sales ratio measures how much of a company's purchases are on credit and have not been paid yet. These ratios are not necessarily directly related, as a company could have high sales on credit but low purchases on credit, or vice versa. Thus, a high receivables-to-sales ratio does not necessarily mean a high payables-to-sales ratio.

Question 8

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 in order to hold onto cash longer. This imposes a real financial cost on the supplier, as it means they have to find alternative sources of financing to cover their own costs in the meantime. While it may not be an immediate cost to the supplier if the customer eventually pays off the balance, it still represents a financial risk and potential cost.

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 its average collection period and too strict a policy can result in lost sales and reduced profits.

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 statement is true because the credit period offered by the supplier directly affects the customer's cash conversion cycle, which is the time it takes for the customer to turn inventory into cash. A longer credit period will give the customer more time to sell their inventory and generate revenue, which shortens their CCC. However, it also means that the supplier will have to wait longer to receive payment, which lengthens their own CCC. Overall, the credit terms offered by the supplier should be balanced to benefit both parties.

Question 11

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 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

Synchronization of cash flows means aligning the inflows and outflows of cash in a way that reduces the need for keeping excess cash balances. This technique helps in optimizing the cash management process and can ultimately lead to increased profitability for the firm.

Question 13

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 14

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. In a revolving credit agreement, the firm is committed to a certain amount of funds that can be drawn upon as needed, but must pay a fee on the unused balance to compensate the bank for keeping that amount available.

Question 15

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 16

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 17

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 unexpected fluctuations in cash inflows or expenses.

Question 18

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 increases the percentage of sales made on credit and shortens the length of its collection period sufficiently, then it can keep accounts receivable at their current level. This is because a shorter collection period means that the money from credit sales will be received faster, offsetting the increase in credit sales.

Question 19

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 will be evenly spread out over the month but they are actually concentrated at the beginning of the month, their peak borrowing needs will likely be overstated because their cash balance will appear lower than it actually is for the majority of the month. This can lead the firm to borrow more than it needs to in order to cover expenses, which could result in unnecessary interest charges.

Question 20

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.

Quiz 16: Working Capital