Question 1

The key dimension of credit selection which analyzes an applicant's ability to repay the requested credit focused on cash flows available is ________.

Accepted Answer

Capacity measures an applicant's ability to repay a loan through analyzing their cash flows available. Collateral refers to assets that can be used as security for a loan, capital refers to an applicant's financial strength and resources, and conditions refer to external factors that may impact an applicant's ability to repay a loan (e.g. economic conditions, industry trends).

Question 2

The turnover of accounts receivable can be calculated by dividing 365 days by average collection period.

Accepted Answer

The formula for turnover of accounts receivable is the number of times receivables are collected in a year. This can be calculated by dividing 365 days by the average collection period in days. Therefore, the statement is true.

Question 3

A firm's credit standard is a procedure for ranking an applicant's overall credit strength, derived as a weighted average of scores on key financial and credit characteristics.

Accepted Answer

The answer of A firm's credit standard is a procedure...

Question 4

One of the key inputs to the final credit decision is a credit analyst's subjective judgment of a firm's creditworthiness since it can provide a better feel of a firm's operation than any quantitative figures.

Accepted Answer

The answer of One of the key inputs to the...

Question 5

The key dimension of credit selection which analyzes an applicant's record of meeting past obligations is ________.

Accepted Answer

The key dimension of credit selection which analyzes an applicant's record of meeting past obligations is character. This evaluates the applicant's willingness to repay the loan based on their credit history and other personal factors such as employment stability and payment patterns. Collateral, capacity, and capital are also important dimensions of credit selection, but they focus on the value of an applicant's assets, income, and net worth, respectively.

Question 6

A firm's credit standards are the minimum requirements for extending credit to a customer.

Accepted Answer

A firm sets its credit standards based on various factors like credit score, payment history, income, etc. These standards are the minimum requirements that a customer needs to meet in order to be eligible for credit from the firm.

Question 7

The cost of marginal investment in accounts receivable can be calculated by finding the difference between the average investment in accounts receivable before and after the introduction of the changes in credit standards.

Accepted Answer

The cost of marginal investment in accounts receivable is calculated by considering the additional investment in accounts receivable due to changes in credit policies, not just the difference in average investment before and after these changes. It involves assessing the incremental costs associated with the additional accounts receivable, including factors like the cost of additional financing and potential bad debt expenses.

Question 8

Increasing the length of the credit period can increase sales, but both the investment in accounts receivable and bad debt expenses are likely to increase as well.

Accepted Answer

Increasing the credit period means customers have more time to pay, which can boost sales. However, this also means a longer wait for payment and a higher risk of customers not paying at all, leading to both increased investment in accounts receivable and bad debt expenses.

Question 9

The objective for managing accounts receivable is to avoid credit sales as much as possible.

Accepted Answer

The objective for managing accounts receivable is to collect payments on credit sales as efficiently as possible, while minimizing the risk of bad debts. Avoiding credit sales altogether may not be feasible or desirable for some businesses.

Question 10

A relaxation of credit standards is expected to affect profits positively due to lower carrying costs, whereas tightening credit standards would affect profits negatively as a result of higher carrying costs.

Accepted Answer

Relaxation of credit standards can lead to higher sales and potentially higher profits due to increased customer base, but it also increases the risk of bad debts and carrying costs due to extended credit terms. Tightening credit standards might reduce sales volume but can lead to lower carrying costs and bad debt expenses, potentially stabilizing or improving profits.

Question 11

As credit standards are relaxed, sales are expected to increase and the investment in accounts receivable is expected to decrease.

Accepted Answer

When credit standards are relaxed, sales are expected to increase because more customers are able to buy on credit. However, the investment in accounts receivable is expected to increase, not decrease, because more sales on credit result in more outstanding receivables.

Question 12

By increasing collection expenditures, a firm can decrease bad debt losses up to a point, beyond which bad debts cannot be economically reduced.

Accepted Answer

Increasing collection expenditures can improve the efficiency of collecting debts and reduce bad debt losses. However, there is a point where further investment in collection expenditures will not result in further reduction in bad debts, making it uneconomical to continue. This is because the cost of collecting the debts may exceed the potential recovery value of the debts. Therefore, beyond that point, bad debts cannot be economically reduced.

Question 13

________ is a procedure resulting in a number reflecting an applicant's credit strength, derived as a weighted average of the scores obtained on a variety of key financial and credit characteristics.

Accepted Answer

Credit scoring is a procedure that results in a number reflecting an applicant's credit strength. It is calculated by considering various financial and credit characteristics, like credit history, outstanding debts, and payment history, and determining their weighted average score. This number helps lenders determine the risk associated with lending money to a particular person or entity.

Question 14

The cost of marginal bad debts is found by multiplying a firm's opportunity cost by the difference between the level of bad debts before and after the relaxation of credit standards.

Accepted Answer

The cost of marginal bad debts is actually found by multiplying the additional bad debts that result from relaxing credit standards by the cost per dollar of bad debt, not by the firm's opportunity cost.

Question 15

If a firm relaxes its credit standards, the volume of accounts receivable increases and so does the firm's carrying cost.

Accepted Answer

When a firm relaxes its credit standards, it is likely to sell more products or services on credit, which increases the volume of accounts receivable. However, this also means that the firm is taking on more credit risk, which results in higher carrying costs such as bad debts, collection costs, and the cost of financing the accounts receivable.

Question 16

The average investment of a firm in accounts receivable is equal to the firm's total variable cost of annual sales divided by its average collection period.

Accepted Answer

The average investment in accounts receivable is typically calculated as the firm's annual credit sales divided by 365 days, then multiplied by the average collection period. It is not directly related to the firm's total variable cost of annual sales.

Question 17

A firm's credit selection procedures must be established on a sound economic basis that considers the costs of investigating the creditworthiness of a customer and the expected size of its credit purchases.

Accepted Answer

A firm's credit selection procedures should indeed be based on an economic analysis that takes into account the costs associated with researching a customer's creditworthiness and the anticipated value of its credit transactions. This will allow the firm to make informed decisions about whether or not to extend credit to a particular customer, and under what terms and conditions.

Question 18

In analyzing an applicant's creditworthiness, a credit manager typically gives primary attention to two of the five C's of credit-collateral and condition-since they represent the most basic requirements for extending credit to an applicant.

Accepted Answer

The two primary C's of credit that a credit manager typically gives primary attention to are character and capacity, not collateral and condition. Collateral and condition may be considered as well, but they are not the most basic requirements for extending credit.

Question 19

________ are established to evaluate a customer's creditworthiness and to determine the minimum requirements for extending credit to a customer.

Accepted Answer

Credit standards are established by businesses to evaluate a customer's creditworthiness and to determine the minimum requirements for extending credit to a customer. Credit limits and lines of credit are the terms and conditions set by a business for the amount of credit extended to a customer, while collection agencies are third-party entities hired to collect outstanding debts from customers.

Question 20

The increase in bad debts associated with tightening credit standards raises bad debt expenses and has a negative impact on profits.

Accepted Answer

Tightening credit standards typically leads to a decrease in bad debts because stricter criteria are applied to whom credit is extended, reducing the likelihood of default.

Quiz 15: Working Capital and Current Assets Management