Chapter 15 TB Flashcards
Short-term financial management is concerned with management of a firm’s current assets and current liabilities to achieve a balance between profitability and risk.
T or F?
TRUE
Firms are able to reduce financing costs or increase the funds available for expansion by maximizing the amount of funds tied up in working capital.
T or F?
TRUE
A long-term trend in U.S. companies is that ________.
A) firms are increasing their investments in current assets relative to total assets, and most of this increase has occurred as firms increase their cash holdings
B) firms are increasing their investments in current assets relative to total assets, and most of this increase has occurred as firms increase their inventory balances
C) firms are decreasing their investments in current assets relative to total assets, and most of this decrease has occurred as firms decrease their cash holdings
D) firms are decreasing their investments in current assets relative to total assets, and most of this decrease has occurred as firms decrease their inventory balances
D
On average in recent years, U.S. firms have been increasing their cash balances relative to total assets.
T or F?
TRUE
Working capital refers to a firm’s long-term capital.
T or F?
FALSE
The more predictable a firm’s cash inflows, the more net working capital it will need.
T or F?
FALSE
As firms are unable to match cash inflows to outflows with certainty, most of them need current liabilities.
T or F?
FALSE
When current assets exceed current liabilities, a firm has negative net working capital.
T or F?
FALSE
When current assets exceed current liabilities, a firm has positive net working capital.
Net working capital can be defined as the portion of a firm’s current assets financed with long-term funds.
T or F?
FALSE
A firm that is unable to pay its bills as they come due is said to be insolvent.
T or F?
TRUE
In general, the greater a firm’s current assets relative to its short-term obligations, the better able it will be to pay its bills as they come due.
T or F?
TRUE
As the ratio of current assets to total assets increases, a firm’s risk increases.
T or F?
FALSE
Too much investment in current assets reduces firm’s profitability, whereas too little investment in current assets increases the risk of not being able to pay debts as they come due.
T or F?
TRUE
A firm is said to be insolvent when its total assets is less than its total liabilities and stockholders’ equity.
T or F?
FALSE
An increase in current assets increases net working capital, thereby reducing the risk of insolvency.
T or F?
TRUE
Assuming that the level of total assets remains unchanged, the effect of a decrease in the ratio of current assets to total assets is an increase in a firm’s risk of insolvency.
T or F?
TRUE
The goal of working capital management is to ________.
A) achieve a balance between short-term and long-term liabilities so that they add to the achievement of a firm’s overall goals
B) achieve a balance between a firm’s non-current assets and non-current liabilities
C) achieve a balance between profitability and risk that contributes positively to a firm’s value
D) achieve a balance between short-term and long-term assets so that they add to the achievement of a firm’s overall goals
C
The purpose of managing current assets and current liabilities is to ________.
A) achieve a balance between short-term and long-term financing of a firm
B) achieve as low a level of current liabilities as possible
C) achieve a balance between profitability and risk that contributes to a firm’s value
D) achieve as high a level of current liabilities as possible
C
Net working capital is defined as ________.
A) total assets minus total liabilities
B) total liabilities minus total assets
C) current liabilities minus current assets
D) current assets minus current liabilities
D
Which of the following is true of net working capital?
A) When current assets of a firm exceed its current liabilities,a firm is said to have negative net working capital.
B) When current assets of a firm are less than its total assets,a firm is said to have positive net working capital.
C) When current assets of a firm exceed its current liabilities,a firm is said to have positive net working capital.
D) When current assets of a firm exceed its total assets,the firm is said to have negative net working capital.
C
The conversion of current assets ________.
A) from cash to receivables to inventory provides the cash used to pay non-current liabilities
B) from inventory to receivables to marketable securities provides the cash used to buy plant and equipment
C) from inventory to receivables to cash provides the cash used to pay current liabilities
D) from cash to receivables to inventory provides the cash used to repurchase stock
C
Current liabilities can be viewed as ________.
A) debts that mature in a period of one year or less
B) liabilities which represent a firm’s long-term financing
C) sources of cash inflows from the operating activities of a firm
D) funds used to finance the noncurrent assets’ portion of a firm
A
Which of the following is true of current assets?
A) The time of conversion of current assets to more liquid form is relatively unpredictable.
B) They are used to fund long-term operations and pay long-term expenses.
C) They are more profitable because they add more value to the product than that provided by fixed assets.
D) They are sources of short-term financing for a firm.
A
In general, the more net working capital a firm has, ________.
A) the greater its risk
B) the lower its risk
C) the less likely are creditors to lend to the firm
D) the lower its level of long-term funds
B
A(n) ________ in current assets increases net working capital, thereby ________ the risk of insolvency.
A) decrease; increasing
B) increase; increasing
C) increase; reducing
D) decrease; reducing
C
A decrease in current assets and an increase in current liabilities will ________ net working capital, thereby ________ the risk of insolvency.
A) increase; increasing
B) decrease; increasing
C) increase; reducing
D) decrease; reducing
B
When a portion of a firm’s fixed assets are financed with current liabilities, ________.
A) the firm will have positive net working capital
B) the net working capital will decrease
C) the current ratio will increase
D) the firm will have negative net working capital
B
Which of the following is true of the impact of cash flows on net working capital?
A) The higher the cash inflows lower is the net working capital.
B) The lower the cash outflows lower is the net working capital.
C) The more predictable the cash inflows of a firm, the more current assets a firm needs.
D) The more predictable the cash inflows of a firm, the easier is the working capital management.
D
In working capital management, risk is measured by the probability that a firm will be ________.
A) unable to pay annual dividends to stockholders
B) unable to pay its bills as they come due
C) unable to repay its long-term obligations
D) unable to earn profits from day-to-day operations
B
If a firm increases its current assets relative to total assets, ________.
A) it increases return and reduces risk
B) it increases return and increases risk
C) it reduces return and reduces risk
D) it reduces return and increases risk
C
The cash conversion cycle of a firm is the length of time from the beginning of the production
process to the collection of cash from the sale of finished products.
T or F?
FALSE
The operating cycle is the recurring transition of a firm’s working capital from cash to inventories and inventories to receivables and back to cash.
T or F?
TRUE
The operating cycle is the length of time a firm’s cash is tied up between payment for production inputs and receipt of payment from the sale of the resulting finished product.
T or F?
FALSE
By efficiently managing a firm’s operating and cash conversion cycles, the financial manager can maintain a high level of cash investment and thereby contribute toward maximization of share value.
T or F?
FALSE
A firm’s operating cycle (OC) is simply the sum of the average age of inventory (AAI) and the average payment period (APP).
T or F?
FALSE
The cash conversion cycle is the total number of days in the operating cycle less the average payment period for inputs to production.
T or F?
TRUE
A negative cash conversion cycle (CCC) means the average payment period (APP) exceeds the operating cycle (OC).
T or F?
TRUE
The ability to purchase production inputs on credit allows a firm to partially offset the length of time resources are tied up in the operating cycle.
T or F?
TRUE
The cash conversion cycle of a firm is the difference between the number of days resources are tied up in the operating cycle and the average number of days the firm can delay making payment on the production inputs purchased on credit.
T or F?
TRUE
A positive cash conversion cycle means that a firm must obtain financing to support the cash conversion cycle.
T or F?
TRUE
The cash conversion cycle is the sum of average age of the inventory and average collection period minus average payment period.
T or F?
TRUE
Nonmanufacturing firms are more likely to have positive cash conversion cycles; they generally carry smaller, faster-moving inventories and often sell their products for cash.
T or F?
FALSE
Nonmanufacturing firms are more likely to have negative cash conversion cycles; they generally carry smaller, faster-moving inventories and often sell their products for cash.
The aggressive funding strategy is a strategy by which a firm finances its current assets with short-term funds and its fixed assets with long-term funds.
T or F?
FALSE
If a firm’s sales are constant, its investment in operating assets should also be constant, and the firm will have only a permanent funding requirement.
T or F?
TRUE
The conservative funding strategy is a strategy by which a firm finances at least its seasonal requirements, and possibly some of its permanent requirements, with short-term funds and the balance of its permanent requirements with long-term funds.
T or F?
FALSE
The aggressive funding strategy is a strategy by which a firm finances at least its seasonal requirements, and possibly some of its permanent requirements, with short-term funds and the balance of its permanent requirements with long-term funds.
Under an aggressive funding strategy, a firm funds its seasonal requirements with short-term debt and its permanent requirements with long-term debt.
T or F?
TRUE
One aspect of risk associated with the aggressive strategy’s maximum use of short-term financing is the fact that changing short-term interest rates can result in significantly higher borrowing.
T or F?
TRUE
The aggressive funding strategy is a strategy by which a firm finances all projected funds requirements with long-term funds and uses short-term financing only for emergencies or unexpected outflows.
FALSE
The conservative funding strategy is a strategy by which a firm finances all projected funds requirements with long-term funds and uses short-term financing only for emergencies or unexpected outflows.
The aggressive funding strategy is risky due to its minimum level of net working capital, high dependency on short-term sources of funds, and the changing short-term interest.
T or F?
TRUE
Under conservative funding strategy, short-term financing is used only to finance an emergency, an unexpected outflow of funds, and the variable portion of a firm’s current assets.
T or F?
FALSE
The risk of the conservative funding requirements is low because of its high level of net working capital, and the fact that the strategy does not require a firm to use any of its limited short-term borrowing capacity.
T or F?
TRUE
Under a conservative funding strategy, the firm funds both its seasonal and its permanent requirements with long-term debt.
T or F?
TRUE
When implementing the cash management strategies, a firm should avoid damaging a firm’s credit rating by overstretching accounts payable.
T or F?
FALSE
The ________ of a firm is the amount of time required for a company to convert cash invested in its operations to cash received as a result of its operations.
A) cash turnover
B) cash conversion cycle
C) average age of inventory
D) average collection period
B
The ________ of a firm is the amount of time that elapses from the point when the firm inputs material and labor into the production process to the point when cash is collected from the sale of the finished product that contains these production inputs.
A) cash conversion cycle
B) average age of inventory
C) operating cycle
D) average collection period
C
The ________ is the length of time from the point when raw materials are purchased on account to the point when payment is made to the supplier of the goods.
A) cash conversion cycle
B) average payment period
C) average age of inventory
D) average collection period
B
The ________ is the time period that elapses from the point when a firm uses the raw materials in manufacturing a finished good to the point when the finished good is sold.
A) cash turnover
B) cash conversion cycle
C) average age of inventory
D) average collection period
C
The ________ is the time period that elapses from the point when a firm sells a finished good on account to the point when the receivable is collected.
A) cash conversion cycle
B) average payment period
C) average age of inventory
D) average collection period
D
A firm can reduce its cash conversion cycle by ________.
A) increasing the average age of inventory
B) increasing the average collection period
C) increasing the operating cycle
D) increasing the average payment period
D
Other factors remaining constant, an increase in the average collection period will result in ________.
A) an increase in the operating cycle
B) an increase in the average payment period
C) a decrease in the operating cycle
D) a decrease in the average payment period
A
Other factors remaining constant, an increase in the average payment period will ________.
A) increase the average collection period
B) decrease the operating cycle
C) not affect the cash conversion cycle
D) not affect the operating cycle
D
Other factors remaining constant, a decrease in the average age of inventory will result in ________.
A) a decrease in the average collection period
B) a decrease in the cash conversion cycle
C) an increase in the cash conversion cycle
D) an increase in the average collection period
B
Other factors remaining constant, an increase in the average payment period will result in ________.
A) a decrease in the average collection period
B) a decrease in the cash conversion cycle
C) an increase in the cash conversion cycle
D) an increase in the average collection period
B
Which of the following elements is required for the calculation of cash conversion cycle?
A) current assets ratio
B) average cost of goods sold
C) average collection period
D) cash flows from operations
C
One way to improve the cash conversion cycle is to ________.
A) speed up collections
B) slow down credit approvals
C) slow down inventory turnover
D) speed up payments
A
A firm with highly unpredictable sales revenue would best choose ________ funding strategy to minimize risk.
A) the aggressive
B) the conservative
C) the trade-off
D) a seasonal
B
Certain financing plans are termed conservative when ________.
A) short-term financing is used frequently
B) working capital is relatively high
C) current assets are relatively low
D) risk is increased
B
Which of the following is true of an aggressive funding strategy of a firm?
A) Under an aggressive funding strategy, a firm funds it seasonal requirements with bonds and long-term loans.
B) Under an aggressive funding strategy, a firm funds its seasonal requirements with short-term debt.
C) Under an aggressive funding strategy, a firm funds both its seasonal and its permanent requirements with long-term debt.
D) Under an aggressive funding strategy, a firm funds it permanent requirements with commercial paper and notes payable.
B
An increase in the current asset to total asset ratio will result in ________.
A) an increase in profit
B) an increase in risk
C) a decrease in risk
D) a decrease in profit
C
A decrease in the current asset to total asset ratio will result in ________.
A) an increase in risk
B) a decrease in risk
C) an increase in profit
D) a decrease in profit
B
An increase in the current liabilities to total assets ratio will result in ________.
A) an increase in risk
B) a decrease in risk
C) an increase in profit
D) a decrease in profit
A
An decrease in the current liabilities to total assets ratio will result in ________.
A) an increase in risk
B) an increase in profit
C) a decrease in risk
D) a decrease in profit
C
An increase in the average payment period will ________ the operating cycle and ________ the cash conversion cycle.
A) increase; decrease
B) decrease; decrease
C) decrease; not affect
D) not affect; decrease
D
The difference between the number of days resources are tied up in the operating cycle and the number of days a firm can use spontaneous financing before payment is made is the ________.
A) cash conversion cycle
B) average payment period
C) operating cycle
D) average age of inventory
A
A decrease in the production time to manufacture a finished good will result in ________.
A) an increase in the average age of inventory
B) a decrease in the cash conversion cycle
C) an increase in the cash conversion cycle
D) a decrease in the average age of inventory
B
A negative cash conversion cycle ________.
A) means that the operating cycle exceeds the average inventory period
B) means that the average payment period exceeds the operating cycle
C) indicates that a firm is shortening its average payment period and lengthening its average collection period
D) indicates that a firm is shortening its average age of inventory and average payment period
B
A firm may have a negative cash conversion cycle if it carries ________.
A) very little inventory and sells its products on credit
B) high inventory and sells its products on credit
C) very little inventory and sells its products for cash
D) high inventory and sells its products for cash
C
Improvements to cash management include ________.
A) a reduction in the cash turnover
B) a reduction in the cash conversion cycle
C) an increase in the average age of inventory
D) an increase in the credit period allowed to customers
B
In an aggressive financing strategy, a firm anticipating a large increase in sales for the coming period should finance the increase in working capital with ________.
A) the sale of common stock
B) the sale of a bond issue
C) a line of credit
D) a long-term note from the bank
C
The aggressive financing strategy is risky in two aspects: a firm operates with a possibility of ________, and an inability to engage in ________ when needed.
A) insolvency; short-term borrowing
B) interest rate swings; short-term borrowing
C) low earnings; long-term borrowing
D) fixed interest rate; long-term borrowing
B
In theory, the conservative financing strategy ignores ________.
A) all current liabilities
B) the spontaneous forms of short-term financing
C) all current assets
D) the high risk associated with external financing
B
In economic conditions characterized by a scarcity of short-term funds, a firm would best choose the ________ financing strategy.
A) aggressive
B) conservative
C) permanent
D) seasonal
B
A risk of the ________ financing strategy is unpredictable interest expense.
A) aggressive
B) conservative
C) permanent
D) seasonal
A
The ________ financing strategy requires a firm to pay interest on excess funds borrowed but not needed throughout the entire year.
A) aggressive
B) conservative
C) permanent
D) seasonal
B
The aggressive financing strategy is a ________ method while the conservative financing strategy is a ________ method.
A) high-profit, high-risk; low-profit, low-risk
B) high-profit, low-risk; low-profit, high-risk
C) low-profit, high-risk; high-profit, low-risk
D) low-profit, low-risk; high-profit, high-risk
A
In economic conditions characterized by short-term interest rates which exceed long-term interest rates, the financing strategy that would maximize profits is ________ strategy.
A) the aggressive
B) the conservative
C) the trade-off
D) a seasonal
B
A firm with a very low current ratio in comparison to the industry standard could lower the risk of unavailable short-term funds by moving toward ________ financing strategy.
A) the aggressive
B) the conservative
C) a permanent
D) a seasonal
B
A firm which uses the aggressive financing strategy plans to purchase a major fixed asset financed with a loan. The most likely consequence of this action is ________.
A) a decrease in the current ratio
B) an increase in net working capital
C) a decrease in the risk of insolvency
D) an increase in long-term debt
D
A firm which uses the aggressive financing strategy plans to purchase raw materials in large quantities to take price discounts. The firm will finance the purchase with a long-term loan. The most likely consequence of this action is ________.
A) a decrease in the current ratio
B) an increase in net working capital
C) an increase in risk of insolvency
D) a decrease in net working capital
B
Only a firm’s permanent financing requirement (and not the seasonal requirement) is financed with ________ in the aggressive funding strategy.
A) long-term debt
B) T-bills
C) retained earnings
D) accounts payable
A
A firm’s financing requirements can be separated into ________.
A) current liabilities and short-term funds
B) current assets and fixed assets
C) current liabilities and long-term debt
D) seasonal and permanent
D
The basic strategies for determining the appropriate financing mix are ________.
A) seasonal and permanent funding
B) short-term and long-term financing
C) aggressive and conservative funding
D) current and non-current liabilities
C
If a firm uses an aggressive financing strategy, ________.
A) it increases return and increases risk
B) it increases return and decreases risk
C) it decreases return and increases risk
D) it decreases return and decreases risk
A
One major risk a firm assumes in an aggressive financing strategy is ________.
A) the possibility that collections will be slower than expected
B) the possibility that long-term funds may not be available when needed
C) the possibility that short-term funds may not be available when needed
D) the possibility that it will run out of cash
C
The basic strategies that should be employed by a business firm in managing cash includes ________.
A) paying accounts payable as early as possible
B) turning over inventory as quickly as possible, avoiding stockouts
C) operating in a fashion that requires maximum cash
D) extending the credit period allowed to customers
B
For minimizing the cash conversion cycle, a firm should ________.
A) grant longer credit terms to customers to maintain healthy business relations
B) pay off accounts payables as fast as possible to gain credibility
C) turn over inventory as quickly as possible without stockouts
D) increase mail managing, processing, and clearing time when collecting from customers
C
Because managing inventory is just like managing any other investment, decisions about the level of inventory should be guided by the effect of inventory levels on sales.
T or F?
FALSE
The ABC system is an inventory management technique for determining the optimal order quantity for an item of inventory.
T or F?
FALSE
The reorder point is the point at which a firm receives orders.
T or F?
FALSE
Safety stocks are extra inventories that can be drawn down when actual lead times and/or usage rates are greater than expected.
T or F?
TRUE
In the ABC system of inventory management, the two-bin method or system could be utilized to control C items.
TRUE
In EOQ model, the average inventory is defined as the order quantity divided by 2.
T or F?
TRUE
