Reading 32: working capital and liquidity Flashcards
A company has an agreement with its lender to borrow funds as they need to up to a specified maximum amount and to repay its borrowings as they have funds available. This arrangement is most appropriately called:
a committed line of credit.
a revolving line of credit.
a capped line of credit.
A line of credit where the borrower can draw funds as they need them and repay them when they have the funds available to do so is called a revolving line of credit. (LOS 32.a)
A company receives an invoice of $150,000 for machine tools with terms of “1.5/15 net 40.” The cost to the company of delaying payment of this receivable is most appropriately described as $2,250 for the use of:
$150,000 for 40 days.
$150,000 for 25 days.
$147,750 for 25 days.
The terms indicate that the company can pay $150,000(1 – 0.015) = $147,750 on day 15 (after the invoice date) or pay $150,000 on day 40—effectively gaining the use of $147,750 for 25 days at a cost of $2,250. (LOS 32.a)
Which of the following most likely represents conservative working capital management?
Decreasing inventory on hand to reduce insurance costs.
Financing an increase in receivables by increasing long-term borrowing.
Selling marketable securities and using the proceeds to acquire real estate.
Financing an increase in a current asset with long-term borrowing is an example of conservative working capital management. The other choices describe decreases in current assets and therefore more likely represent aggressive working capital management. (LOS 32.b)
An example of a primary source of liquidity is:
liquidating assets.
negotiating debt contracts.
short-term investment portfolios.
Primary sources of liquidity include ready cash balances, short-term funds (e.g., short-term investment portfolios), and effective cash flow management. Secondary sources of liquidity include renegotiating debt contracts, liquidating assets, and filing for bankruptcy protection and reorganization. (LOS 32.c)
Firm P and Firm Q have the same current assets and current liabilities, but Firm P has a lower quick ratio than Firm Q. Compared with Firm Q, it is most likely that Firm P has:
greater inventory.
greater payables.
a higher receivables turnover ratio.
Firms P and Q will have the same current ratios, CA/CL. The quick ratio numerator is CA – inventory, so for firm P to have a smaller quick ratio than firm Q, it must have greater inventory. (LOS 32.d)
A company would best improve its cash conversion cycle by decreasing its:
receivables turnover.
payables turnover.
inventory turnover.
A decrease in the payables turnover would increase days payables, which would decrease (improve) the firm’s cash conversion cycle. A decrease in a company’s receivables turnover would increase days receivables, and a decrease in a company’s inventory turnover would increase its days inventory on hand. Both would increase the cash conversion cycle. (LOS 32.d)
