Working Capital Missed Questions Flashcards
Selected data from Sheridan Corporation’s year-end financial statements are presented below. The difference between average and ending inventory is immaterial.
Current ratio 2.0
Quick ratio 1.5
Current liabilities $120,000
Inventory turnover (based on cost of goods sold) 8 times
Gross profit margin 40%
Assuming no prepaid expenses are included in current assets, Sheridan’s net sales for the year were
A. $480,000
B. $1,200,000
C. $240,000
D. $800,000
D. $800,000
Net sales can be calculated indirectly from the inventory turnover ratio and the other ratios given. If the current ratio is 2.0, and current liabilities are $120,000, current assets must be $240,000 (2.0 × $120,000). Similarly, if the quick ratio is 1.5, the total quick assets must be $180,000 (1.5 × $120,000). The difference between quick assets and current assets is that inventory is not included in the quick assets. Consequently, ending inventory must be $60,000 ($240,000 – $180,000). The inventory turnover ratio (COGS ÷ Average inventory) is 8. Thus, cost of goods sold must be 8 times average inventory, or $480,000, given no material difference between average and ending inventory. If the gross profit margin is 40%, the cost of goods sold percentage is 60%, cost of goods sold equals 60% of sales, and net sales must be $800,000 ($480,000 ÷ 60%).
A company has credit sales of $20,000 in January, $30,000 in February, and $50,000 in March. The company collects 75% in the month of sale and 25% in the following month. The balance in accounts receivable on January 1 was $25,000. What amount is the balance in accounts receivable at closing on March 31?
A. $7,500
B. $37,500
C. $12,500
D. $45,000
C. $12,500
The company collects 75% of credit sales in the month of sale and 25% in the following month. Accordingly, the accounts receivable balance of $25,000 on January 1 (carried over from December) was collected in January; the credit sales of $20,000 in January were fully collected in February; the credit sales of $30,000 in February were fully collected in March; and $37,500 ($50,000 × 75%) of the $50,000 in credit sales in March were collected in March. Therefore, the balance in accounts receivable at closing on March 31 is $12,500 ($50,000 × 25%).
A company obtained a short-term bank loan of $500,000 at an annual interest rate of 8%. As a condition of the loan, the company is required to maintain a compensating balance of $100,000 in its checking account. The checking account earns interest at an annual rate of 3%. Ordinarily, the company maintains a balance of $50,000 in its account for transaction purposes. What is the effective interest rate of the loan?
A. 8.22%
B. 7.77%
C. 8.56%
D. 9.25%
C. 8.56%
The $100,000 compensating balance requirement is partially satisfied by the company’s practice of maintaining a $50,000 balance for transaction purposes. Thus, only $50,000 of the loan will not be available for current use, leaving $450,000 of the loan usable. At 8% interest, the $500,000 loan would require an interest payment of $40,000 per year. This is partially offset by the 3% interest earned on the $50,000 incremental balance, or $1,500. Subtracting the $1,500 interest earned from the $40,000 of expense results in net interest expense of $38,500 for the use of $450,000 in funds. Dividing $38,500 by $450,000 produces an effective interest rate of 8.56%.
Fact Pattern: Tosh Enterprises reported the following account information:
Accounts receivable $400,000
Accounts payable 260,000
Bonds payable, due in 10 years 600,000
Cash 200,000
Interest payable, due in 3 months 20,000
Inventory $800,000
Land 500,000
Short-term prepaid expense 80,000
The current ratio for Tosh Enterprises is
A. 5.29
B. 1.68
C. 5.00
D. 2.14
A. 5.29
The current ratio equals current assets divided by current liabilities. Current assets consist of accounts receivable, cash, inventory, and prepaid expenses, a total of $1,480,000 ($400,000 + $200,000 + $800,000 + $80,000). Current liabilities consist of accounts payable and interest payable, a total of $280,000 ($260,000 + $20,000). Hence, the current ratio is 5.29 ($1,480,000 ÷ $280,000).
Carter Co. had the following items on its balance sheet at the end of the current year:
Cash and cash equivalents $ 200,000
Short-term investments 100,000
Accounts receivable 400,000
Inventories 600,000
Patent–10 years 300,000
Equipment 1,000,000
Accumulated depreciation 200,000
The amount of current liabilities at the end of the current year was $640,000. What is Carter’s working capital at the end of the current year?
A. $660,000
B. $60,000
C. $960,000
D. $560,000
A. $660,000
Working capital is calculated as current assets minus current liabilities. The current assets in this question total $1,300,000 ($200,000 + $100,000 + $400,000 + $600,000). The current liabilities are given as $640,000. Therefore, the working capital at the end of the current period is $660,000 ($1,300,000 – $640,000).
Fact Pattern: Depoole Company is a manufacturer of industrial products that uses a calendar year for financial reporting purposes. Assume that total quick assets exceeded total current liabilities both before and after the transaction described. Further assume that Depoole has positive profits during the year and a credit balance throughout the year in its retained earnings account.
Depoole’s purchase of raw materials for $85,000 on open account will
A. Decrease the current ratio.
B. Increase net working capital.
C. Decrease net working capital.
D. Increase the current ratio.
A. Decrease the current ratio.
The purchase increases both the numerator and denominator of the current ratio by adding inventory to the numerator and payables to the denominator. Because the ratio before the purchase was greater than 1, the ratio is decreased.
The following account balances were taken from Spector Co.’s balance sheet at December 31 of the current and previous year:
Current year Previous year Cash $ 20,000 $ 10,000 Accounts receivable 300,000 310,000 Inventory 120,000 130,000 Short-term notes receivable 60,000 50,000 Plant and equipment 600,000 540,000 Bond sinking fund 200,000 190,000 Current liabilities 300,000 250,000
Which of the following statements regarding the current ratio and working capital is correct?
A. Working capital decreased in the current year.
B. Working capital increased in the current year.
C. The current ratio is the same in the current year as it was in the previous year.
D. The current ratio increased in the current year.
A. Working capital decreased in the current year.
The current ratio equals current assets divided by current liabilities. Working capital equals current assets minus current liabilities. Spector Co.’s current assets consist of cash, accounts receivable, inventory, and short-term notes receivable. The plant and equipment and bond sinking fund balances are excluded from the calculation because they are a noncurrent asset and a long-term liability, respectively.
Current year:
Current ratio = Current assets ÷ Current liabilities
= ($20,000 + $300,000 + $120,000 + $60,000) ÷ $300,000
= 1.67
Working capital = Current assets – Current liabilities
= ($20,000 + $300,000 + $120,000 + $60,000) – $300,000
= $200
Previous year:
Current ratio = Current assets ÷ Current liabilities
= ($10,000 + $310,000 + $130,000 + $50,000) ÷ $250,000
= 2
Working capital = ($10,000 + $310,000 + $130,000 + $50,000) – $250,000
= $250
Therefore, both the current ratio and working capital decreased in the current year.
Fact Pattern: Morton Company needs to pay a supplier’s invoice of $50,000 and wants to take a cash discount of 2/10, net 40. The firm can borrow the money for 30 days at 12% per annum plus a 10% compensating balance.
The amount Morton Company must borrow to pay the supplier within the discount period and cover the compensating balance is
A. $55,556
B. $55,056
C. $54,444
D. $55,000
C. $54,444
Morton’s total borrowings can be calculated as follows:
Total borrowings = Amount needed ÷ (1.0 – Compensating balance %)
= ($50,000 × 98%) ÷ (100% – 10%)
= $49,000 ÷ 90%
= $54,444
In computing the reorder point for an item of inventory, which of the following is used?
I. Cost
II. Usage per day
III. Lead time
A. I and II.
B. I, II, and III.
C. I and III.
D. II and III.
D. II and III.
The reorder point is the amount of inventory on hand indicating that a new order should be placed. It equals the sales per unit of time multiplied by the time required to receive the new order (lead time).
Fact Pattern: Skilantic Company needs to pay a supplier’s invoice of $60,000 and wants to take a cash discount of 2/10, net 40. The firm can borrow the money for 30 days at 11% per annum plus a 9% compensating balance.
The amount Skilantic Company must borrow to pay the supplier within the discount period and cover the compensating balance is
A. $60,000
B. $58,800
C. $65,934
D. $64,615
D. $64,615
Skilantic’s total borrowings on this loan can be calculated as follows:
Total borrowings = Amount needed ÷ (1.0 – Compensating balance %)
= ($60,000 × 98%) ÷ (100% – 9%)
= $58,800 ÷ 91%
= $64,615
Each of the following business functions is considered part of a company’s value chain except
A. Customer service.
B. Research and development.
C. Marketing.
D. Accounting.
D. Accounting.
A value-added cost is the cost of an activity that increases the value of a product or service to the customer. Although accounting is an important function for every firm, it does not add any value to the product for the customer.
The result of the economic order quantity (EOQ) formula indicates the
A. Safety stock plus estimated inventory for the year.
B. Annual quantity of inventory to be carried.
C. Quantity of each individual order during the year.
D. Annual usage of materials during the year.
C. Quantity of each individual order during the year.
The EOQ model is a deterministic model that calculates the ideal order (or production lot) quantity given specified demand, ordering or setup costs, and carrying costs. The model minimizes the sum of inventory carrying costs and either ordering or production setup costs.
Badoglio Co.’s current ratio is 3:1. Which of the following transactions would normally increase its current ratio?
A. Selling inventory on account.
B. Purchasing machinery for cash.
C. Collecting an account receivable.
D. Purchasing inventory on account.
A. Selling inventory on account.
The current ratio is equal to current assets divided by current liabilities. Given that the company has a current ratio of 3:1, an increase in current assets or decrease in current liabilities would cause this ratio to increase. If the company sold merchandise on open account that earned a normal gross margin, receivables would be increased at the time of recording the sales revenue in an amount greater than the decrease in inventory from recording the cost of goods sold. The effect would be an increase in the current assets and no change in the current liabilities. Thus, the current ratio would be increased.
Clay Corporation follows an aggressive financing policy in its working capital management while Lott Corporation follows a conservative financing policy. Which one of the following statements is correct?
A. Clay has less liquidity risk while Lott has more liquidity risk.
B. Clay has a low current ratio while Lott has a high current ratio.
C. Clay’s interest charges tend to be higher than Lott’s interest charges.
D. Clay has a low ratio of short-term debt to total debt while Lott has a high ratio of short-term debt to total debt.
B. Clay has a low current ratio while Lott has a high current ratio.
A conservative working capital management financing policy uses permanent capital to finance permanent asset requirements and also some or all of the firm’s seasonal demands. Thus, Lott’s current ratio (current assets/current liabilities) will be high since its current liabilities will be relatively low. An aggressive policy entails financing some fixed assets and all the current assets with short-term capital. This policy results in a lower current ratio.
A small store has decided to start accepting credit cards as forms of payment. But subsequent sales were unchanged. Which of the following is true about the effects of accepting payment by credit card?
A. Only II.
B. I and II.
C. II and III.
D. I, II, and III.
B. I and II.
Factoring is an arrangement in which a firm sells its accounts receivable at a discount to a factor, an entity that specializes in collections. The seller receives cash promptly, reducing the cash collection cycle, and eliminates bad debts (credit losses). Also, the seller need not maintain a credit department and an accounts receivable staff. Visa is an example of a factor. Visa remits the cash proceeds to the seller minus a typical fee in the range of 1.5%-4%. Visa assumes the risk that purchasers may not pay their credit card bills. But the factor’s fee reduces cash collections and working capital (Current assets – Current liabilities).
The following information regards a change in credit policy. The company has a required rate of return of 10% and a variable cost ratio of 60%.
The pre-tax cost of carrying the additional investment in receivables, using a 360-day year, would be
A. $8,160
B. $960
C. $5,760
D. $9,600
C. $5,760
The projected ending balance in receivables under the old policy was $300,000 [$3,600,000 × (30 days ÷ 360 days)]. Under the new policy, the ending balance will be $396,000 [$3,960,000 × (36 days ÷ 360 days)]. Hence, the ending balance is $96,000 higher under the new policy ($396,000 – $300,000). The pre-tax cost of carrying the additional investment in receivables can be calculated as follows:
A company wants to change its credit term from 1/10, n/30 to 2/10, n/30. If the sales volume stays constant, what will be the most likely impacts on the company’s following ratios?
B. Decrease Decrease
Which changes in costs are most conducive to switching from a traditional inventory ordering system to a just-in-time ordering system?
C. Decreasing Increasing
Given that sales stay constant, a change in the term of credit from 3/10, n/30 to 1.5/10, n/30 will most likely impact the following ratios in what way?
B. Increase Increase
The following information regarding inventory policy was assembled by the TKF Corporation. The company uses a 50-week year in all calculations.
A. 2,700 units.
B. 240 units.
C. 1,200 units.
D. 5,500 units.
A. 2,700 units.
The reorder point is the inventory level at which an order should be placed. It can be quantified using the following equation:
