Question 1

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

Accepted Answer

This statement is true. A firm's credit standards outline the criteria that a customer must meet in order to be approved for credit. These standards typically include factors such as credit history, income level, and payment history.

Question 2

In analyzing an applicant's creditworthiness, the 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 C's that are given primary attention in analyzing an applicant's creditworthiness are character and capacity, not collateral and condition.

Question 3

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 4

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 5

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 6

The turnover of accounts receivable can be calculated by dividing annual sales by accounts receivable.

Accepted Answer

The turnover of accounts receivable is calculated by dividing annual sales by accounts receivable. It helps in evaluating the efficiency of the company in collecting its outstanding debts from customers.

Question 7

A firm's credit standard is a procedure for ranking of 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 8

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

Accepted Answer

Increasing the length of credit period would mean customers have more time to pay for their purchases, which could encourage them to buy more. However, this also means that the company would need to invest in accounts receivable (money owed to them by customers) for a longer period of time. Additionally, the longer customers have to pay, the higher the risk of some customers not paying at all, leading to an increase in bad debt expenses.

Question 9

A firm's credit ________ provides guidelines for determining whether to extend credit to a customer and how much credit to extend.

Accepted Answer

A firm's credit policy outlines the criteria and procedures for extending credit. It typically includes guidelines for creditworthiness evaluation, payment terms, credit limits, and collections. Credit scoring, terms, and standards are components of the credit policy but do not fully encompass its scope.

Question 10

The average investment 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 calculated as the firm's total credit sales divided by its average collection period, not the total variable cost of annual sales.

Question 11

If the 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 allows more customers to buy on credit, and this increases the volume of accounts receivable. As a result, the firm has to spend more on carrying the accounts receivable, which increases its carrying cost.

Question 12

Credit analysts usually analyze an applicant's creditworthiness by using the dimensions of credit such as character, capacity, capital, collateral, and conditions.

Accepted Answer

This is true. Credit analysts assess the creditworthiness of an applicant based on the five dimensions of credit, which are character, capacity, capital, collateral, and conditions.

Question 13

A firm's credit selection is the process of determining the minimum requirements for extending credit to a customer.

Accepted Answer

A firm's credit selection process involves assessing a customer's creditworthiness and setting criteria for extending credit.

Question 14

One of the key inputs to the final credit decision is the 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 15

A firm's credit policy generally includes determining credit selection, credit terms, and collection.

Accepted Answer

The answer of A firm's credit policy generally includes determining...

Question 16

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

Accepted Answer

The answer of The cost of marginal bad debts is...

Question 17

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.

Question 18

A firm's credit terms specify the minimum requirements for extending credit to a customer.

Accepted Answer

The answer of A firm's credit terms specify the minimum...

Question 19

In international trade when a U.S. company sells a product in France, the U.S. company experiences an exchange rate gain if the franc depreciates against the dollar before the U.S. exporter collects on its accounts receivable.

Accepted Answer

If the franc depreciates against the dollar, the U.S. company will receive fewer dollars when converting the payment from francs to dollars, resulting in an exchange rate loss, not a gain.

Question 20

The 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

The statement is true. The credit selection procedures must take into account the costs of investigating a customer's creditworthiness and the expected size of their credit purchases to ensure sound economic decision-making.

Quiz 15: Working Capital and Current Assets Management