Exam 17: The Management of Working Capital

A low level of cash may force the firm to interrupt operations.

A safety stock is an additional supply of inventory intended to be used when the normal working stock is unexpectedly depleted.

Trust receipts identify the specific units of inventory pledged as collateral for a loan.

A firm's credit policy affects both its credit sales and its ACP.

In most companies, the level of working capital needed to operate efficiently varies with sales.

As long as the borrower adheres to the conditions set forth in a revolving credit agreement, the bank is obligated to advance funds up to the agreed limit.

While a firm's bad debts should rise as it relaxes its credit standards, its ACP should fall.

Net working capital is the difference between current assets and current liabilities.

A lockbox system can eliminate processing float.

Net working capital is the sum of all current assets.

A firm's net working capital reflects the amount of funds required to support its day-to-day routine operations. The word net reflects the fact that the requirement is net of spontaneous financing.

Explain the idea of spontaneous financing and explain why, in spite of it, we still have to fund working capital from outside sources.

Ordering costs are a function of the amount of inventory held.

"Leaning on the trade" is an expression associated with a customer's insistence that vendors extend more liberal credit terms.

Marketable securities are also referred to as near cash or cash equivalents.

Under just-in-time (JIT) inventory systems, manufacturers shifts the task of maintaining inventory to their suppliers, who in turn shift it to their own suppliers.

A firm's collection policy refers to how quickly and aggressively a firm oversees the management of all of its receivables.

Because of the short-term nature of working capital assets and liabilities, it is always necessary to support working capital with short-term borrowing. To do otherwise would violate the matching principle, which is of paramount importance in financial management.

The interest rate on commercial paper normally exceeds the prime rate.

Virtually all accruals are best guess estimates of obligations arising from merchandise purchases for which vendor invoices have not yet been received.