WORKING CAPITAL MANAGEMENT

I. True or False

Instruction: Write “T” if your answer is True and “F” if your answer is False.

1. Working capital management includes several basic business relationships including

the sales impact and liquidity, but not the relations with stakeholders.
2. Working capital management consists of managing a firm's current assets and
current liabilities (where current refers to one year or less).
3. Net working capital may be defined as current assets minus current liabilities. This
also defines the current ratio.
4. Determination of a firm’s investment in net operating working capital and how that
investment is financed are elements of working capital policy.
5. The cash conversion cycle is the length of time between the payment of accounts
payable and the receipt of cash from marketable securities.
6. In the maturity-matching approach, the firm hedges its risk by matching the
maturities of its assets and liabilities.
7. A transaction balance is an account balance that the firm agrees to maintain.
8. Working capital represents refers to a firm's long term capital.
9. The average accounts receivables balance is determined jointly by the volume of
credit sales and the days’ sales outstanding.
10. If a firm has a large percentage of accounts over 30 days old, it it’s a sign that the
firm’s receivables management need to be reviewed and improved.
11. The aging schedule is a commonly used method of monitoring receivables.
12. Offering trade credit discounts is costly to a firm and as a result, firms that offer
trade discounts are usually those that are performing poorly and need cash quickly.
13. A firm changes its credit policy from 2/10, net 30 to 3/10, net 30. The change is
meant to meet competition, so no increase in sales is expected. Average accounts
receivable will probably decline as a result of this change.
14. If a firm is offered credit terms of 2/10, net 30, it is in the firm’s financial interest to
pay as early as possible during the discount period.
15. The four major elements in a firm’s credit policy are credit standards, discounts
offered, credit period and collection policy.
16. Since receivables and payables both result from sales transactions, a firm with a high
receivables-to-sales ratio will also have a high payables-to-sales ratio.
17. Inventory management is the planning, organizing, and controlling activities that
focus on the flow of materials into, through and from the organization.
18. Carrying costs arise when an organization experiences an ability to deliver its goods
to its customers.
19. Purchasing costs arise in preparing and issuing purchase orders, receiving and
inspecting the items included in the orders, and matching invoices received,
purchase orders, and delivery records to make payments.
20. Insurance and taxes on inventory are part of the costs known as setup or ordering
costs.
21. One function of inventory is to take advantage of quantity discounts.
22. In the simple EOQ model, if annual demand were to increase, the EOQ would
increase proportionately.
23. In the production order quantity (POQ) model, inventory does not arrive in a single
moment but flows in at a steady rate, resulting in a larger lot size than in an
otherwise identical EOQ problem.
24. Since its objective is to minimize inventory investment, a Just-in-Time (JIT) system
uses no, or very little, safety stocks.
25. The cash conversion cycle measures a firm’s financing gap in terms of time.
26. Increases in the cash conversion cycle will lower the firm’s short-term financing needs.
27. If the cash conversion cycle is shorter, then the firm’s investment in inventories and
receivables will be smaller
28. Activities that decrease the cash conversion cycle will increase the firm’s need to
obtain financing.
29. A cash budget is a tool the treasurer uses to forecast future cash flows and estimate
future short-term borrowing needs.
30. To construct a cash budget, two sets of information are needed: estimated cash inflows
and estimated cash outflows.
31. The estimated cash inflows are affected by the sales forecast and customer payment
patterns.
32. A cash budget is a tool the treasurer uses to forecast future cash flows and estimate
future short-term borrowing needs.
33. Accounts payable is money owed by a company to its creditors. True
34. When deciding whether or not take a trade discount, cost of the borrowing funds
should be compared to cost of trade credit to determine if cash discount should be
taken. True
35. The calculated cost of trade capital for a firm that buys the terms of 2/10, net 30 is
lower if the firm pays in 40 days than it pays in 30 days. False
36. If a firm’s suppliers stop offering discounts, then its use of trade credit is more likely
to increase than to decrease. True
37. A firm is said to be extending net trade credit when its accounts receivable are less
than its accounts payable. False
38. As a rule, managers should try to always use the free component of trade credit but
should use the costly component only if the cost of this credit is lower than the costs
of credit from other sources. True
39. If a firm fails to take trade credit discounts it may cost the firm money but generally
such a policy has a negligible effect on the firm's income statement and no effect on
the firm’s balance sheet. False
40. Offering trade credit discounts is costly to a firm and as a result, firms that offer
trade discounts are usually those that are performing poorly. False
II. Multiple Choice

Instruction: Encircle the letter that corresponds to your answer.

1. Credit-policy decisions involve all aspects of receivables management. The decision does
not include which of the following?
a. setting evaluation methods and credit standards
b. the choice of credit terms.
c. monitoring receivables and avoiding actions for slow payment
d. controlling and administering the firm’s credit functions

2. Which of the following statements is false?

a. The invoice is a written statement about goods that were ordered, along with their
prices and the payment dates. In other words, the invoice is simply the bill for
purchases.
b. For the 4/10, net 40 credit terms, you are offering a total credit period of 30 days
from the date of the invoice, a discount period of 10 days, and a 4% discount if paid
on or before the discount period expires.
c. When a firm is using invoice billing, the invoice that accompanies shipment is a
separate bill to be paid.
d. none of these

3. Most credit sales are made on an open account basis, which means .
a. that customers simply purchase what they want.
b. that suppliers dictate the terms of the purchase.
c. that customers cannot simply purchase what they want.
d. that suppliers cannot dictate the terms of the purchase.

4. Which of the below statements is false?

a. Higher collection costs reduce the NPV and but cannot cause it to be negative.
b. A customer who is likely to make late payments is also more likely to default and to
require extra collection efforts.
c. Credit bureau reports give information about any legal judgments against the firm.
d. none of these

5. Credit standards depend on the .

a. variables that determine the NPV of the sale.
b. investment in the sale.
c. probability of payment.
d. all of these

6. A change in a seller’s credit policy caused the following:

 Sales Decreased
 Discounts taken decreased
  Investment in accounts receivable increased
 The number of doubtful accounts increased.

Based on this information, we can say that

a. The company increased the rate of discount offered

b. The net profit has decreased
c. Gross profit has increased
d. The average collection period has increased.

7. Which of the following represents a firm’s average gross receivables balance?

I. Average age in days of receivables x average daily sales
II. Average daily sales x average collection period
III. Annual credit sales ÷ accounts receivable turnover

a. I only c. II only
b. I and II only d. I, II, and III

8. An objective of accounts receivable management is to have both the optimal amounts of

receivables outstanding and bad debts. This balance requires the trade-off between the
benefit of more credit sales and
a. The cost of sales
b. More bad debts
c. The cost of accounts receivables, such as collection, interest and cost of bad debts
d. A high accounts receivable turnover.

9. Net working capital is defined as

a. a ratio measure of liquidity best used in cross-sectional analysis.
b. the portion of the firm's assets financed with short-term funds.
c. current liabilities minus current assets.
d. current assets minus current liabilities
10. In working capital management, risk is measured by the probability that a firm will
become
a. liquid.
b. technically insolvent.
c. unable to meet long-term obligations.
d. less profitable.
11. The goal of working capital management is to
a. balance current assets against current liabilities.
b. pay off short-term debts.
c. achieve a balance between risk and return in order to maximize the firm's value.
d. achieve a balance between short-term and long-term assets so that they add to the
achievement of the firm's overall goals.
12. 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.
13. A(n) ________ in current assets ________ net working capital, thereby ________ the risk
of technical insolvency.
a. decrease; increases; increasing
b. increase; decreases; increasing
c. increase; increases; reducing
d. decrease; decreases; reducing
14. The conversion of current assets from inventory to receivables to cash provides the
________ of cash used to pay the current liabilities, which represents a(n) ________ of
cash.
a. outflow; inflow
b. use; source
c. source; use
d. inflow; outflow
15. The most difficult set of accounts to predict are
a. current assets.
b. stockholder's equity.
c. fixed assets.
d. long-term debt.

16. says to calculate the incremental after-tax cash flows connected with working
capital decisions.
a. The Signaling Principle
b. The Principle of Incremental Benefits
c. The Principle of Time Value of Money
d. The Options Principle
17. The ________ inventory contains The ________ inventory consists of all items currently
in the production process.
a. raw materials
b. work-in-process
c. finished goods
d. capital goods capital goods
18. The ________ inventory consists of items that have been produced but not yet sold.
a. raw materials
b. work-in-process
c. finished goods
d. capital goods

19. The ________ inventory consists of all items currently in the production process.
a. raw materials
 b. work-in-process
c. finished goods
d. capital goods
20. The three basic types of inventory are all of the following EXCEPT
a. raw materials
b. work-in-process
c. finished goods
d. capital goods
21. The philosophy of the ________ is that the firm would have only work-in-process
inventory.
a. basic economic order quantity system
b. materials requirement planning system
c. just-in-time system
d. red-line method
22. The economic order quantity (EOQ) is the order quantity which minimizes
a. the order cost per order.
b. the total inventory costs.
c. the carrying costs per unit per period.
d. order quantity in units.
23. Because managing inventory is just like managing any other investment, decisions about
the level of inventory should be guided by
a. the value of the inventory.
b. the effect of inventory levels on sales.
c. a cost-benefit analysis.
d. the effect of inventory levels on customer relations.
24. The ________ is an inventory management technique that minimizes inventory
investment by having materials inputs arrive at exactly the time they are needed for
production.
a. ABC system
b. EOQ model
c. MRP system
d. JIT system
25. Which of the following is not commonly regarded as being credit policy variable?
a. Credit period
b. Collection policy
c. Credit standards
d. Cash discounts
e. All of the following are credit policy variable
26. If easing a firm’s credit policy lengthens the collection period and results in a worsening
of the age schedule, then why do firms take such actions?
a. It normally stimulates sales
b. To meet competitive pressures
c. To increase firm’s deferral period for payables
 d. Statements a and b are correct
27. What is trade credit?
a. Debt arising from credit sales and recorded as an account receivable by the seller and
as an account payable by the buyer
b. Credit received during the discount period.
c. Credit taken in excess of free trade credit, whose cost is equal to the discount lost.
d. A formal, committed line of credit extended by a bank or another lending institution.
28. What is free trade credit?
a. Debt arising from credit sales and recorded as an account receivable by the seller and
as an account payable by the buyer
b. Credit received during the discount period.
c. Credit taken in excess of free trade credit, whose cost is equal to the discount lost.
d. A formal, committed line of credit extended by a bank or another lending institution.
29. What is Costly trade credit?
a. Debt arising from credit sales and recorded as an account receivable by the seller and
as an account payable by the buyer
b. Credit received during the discount period.
c. Credit taken in excess of free trade credit, whose cost is equal to the discount lost.
d. A formal, committed line of credit extended by a bank or another lending institution.
30. Current liabilities can be viewed as:
a. debts due in one year
b. debts due in less than a year.
c. sources of cash inflows
d. sources of cash outflows.
31. Current liabilities are
a. easy to obtain.
b. lower in cost than long-term liabilities.
c. tied to the level of fixed assets.
d. a function of collection policy.
32. A(n) ______ in current liabilities ________ net working capital, thereby ________ the risk
of technical insolvency.
a. decrease; increases; increasing
b. increase; decreases; increasing
c. decrease; decreases; reducing
d. increase; increases; reducing
33. The length of time it takes for the initial cash outflows for goods and services to be
realized as cash inflows from sales is called
a. Product life cycle
b. Manufacturing cycle
c. Vicious cycle
d. Cash conversion cycle
34. An objective of cash management is to
a. Maximize the cash balance to avoid the risk of illiquidity.
b. Minimize the cash balance to maximize the return from idle cash.
 c. Invest cash for a return while retaining sufficient liquidity to satisfy future needs.
d. Reserve as much cash as possible for potential investment opportunities
35. In cash management, the difference between the bank balance for a firm’s account and
the cash balance that the firm shows on its own books is called.
a. Float.
b. Bank charges
c. Interest income
d. Reconciling item
36. Which of the following items is not a marketable security?
a. Treasury Bills
b. Commercial Papers
c. Central Bank Certificate of Indebtedness (CBCIs)
d. Convertible bonds
37. When managing cash and short-term investments in marketable securities, the treasurer
of a corporation is primarily concerned with
a. Liquidity and safety
b. Maximizing the rate of return
c. Maximizing risk
d. Tax avoidance
38. If the average age of the accounts payable is 15 days, the average age of accounts
receivables is 60 days and the average age of inventory is 10 days, the number of days in
the operating cash conversion cycle is
a. 70 days
b. 85 days
c. 55 days
d. 60 days
39. For a manufacturing firm, the most direct way of preparing cash budget requires
incorporation of the following, except
a. Sales projection and credit terms
b. Collection percentages and other cash receipts
c. Estimated purchases and payment terms and other cash disbursements
d. Projected net income and depreciation expenses
40. Statement 1 - The cash conversion cycle measures a firm’s financing gap in terms of
time.
Statement 2 - Increases in the cash conversion cycle will lower the firm’s short-term
financing needs.
a. Only statement 1 is correct.
b. Only statement 2 is correct.
c. Both statements are correct.
d. Neither of the statements are correct.