Midterm Examination True or False Flashcards
[TRUE or FALSE] A firm that follows an aggressive working capital financing approach uses primarily short-term credit and thus is more exposed to an unexpected increase in interest rates than a firm that uses long-term capital and thus follows a conservative financing policy.
ANS: True.
[TRUE or FALSE] Long-term loan agreements always contain provisions, or covenants, that constrain the firm’s future actions. Short-term credit agreements are just as restrictive in order to protect the interest of the lender.
ANS: True.
[TRUE or FALSE] 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.
ANS: False.
BASIS: While delaying payments may not seem like a direct financial cost, it affects the firm’s cash flow and may indicate potential credit risk. If multiple customers delay payments, the firm could face liquidity issues. (Corporate Finance Institute)
[TRUE or FALSE] 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.
ANS: True.
[TRUE or FALSE] Because money has time value, a cash sale is always more profitable than a credit sale.
ANS: False.
BASIS: While cash sales eliminate the risk of non-payment and provide immediate liquidity, credit sales can sometimes lead to higher overall revenue due to increased customer purchasing power and better customer relationships. (Investopedia)
[TRUE or FALSE] 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 tells us that the credit department is functioning efficiently and there are no past-due accounts.
ANS: False.
BASIS: A DSO of 28 days being below the credit period does not necessarily mean there are no past-due accounts. It only indicates the average collection time. Some accounts may still be overdue, while others may be paid early. (Corporate Finance Institute)
[TRUE or FALSE] If a firm takes actions that reduce its days sales outstanding (DSO), then, other things held constant, this will lengthen its cash conversion cycle (CCC) and cause a deterioration in its cash position.
ANS: False.
BASIS: Reducing DSO improves a firm’s cash flow because receivables are collected faster, which shortens the cash conversion cycle rather than lengthening it. (Harvard Business Review)
[TRUE or FALSE] Other things held constant, if a firm “stretches” (i.e., delays paying) its accounts payable, this will lengthen its cash conversion cycle (CCC).
ANS: False.
BASIS: Delaying payments to suppliers actually shortens the cash conversion cycle because the firm holds onto its cash longer before making disbursements. A longer CCC results from slower inventory turnover or delayed receivables collection. (Investopedia)
