Deck 18: Current Asset Management

Question 1

Credit standards refer to the financial importance of a potential customer to the firm in order to qualify for credit.

Answer 1

False

Question 2

The four major elements in a firm's credit policy are (1) credit standards,(2) discounts offered, (3)
credit period, and (4) collection policy.

Answer 2

True

Question 3

Firms hold cash balances in order to complete transactions that are necessary in business operations and as compensation to banks for providing loans and services.

Answer 3

True

Question 4

Cash is often referred to as a nonearning asset. Thus, one goal of cash management is to minimize the amount of cash necessary to conduct business.

Question 5

Net operating working capital, defined as current assets minus current liabilities, is also equal to the current ratio.

Question 6

Float refers to the difference between the firm's available or collected balance at its bank and the firm's book or ledger balance.

Question 7

The average accounts receivables balance is determined jointly by the volume of credit sales and the days sales outstanding.

Question 8

For a typical nonfinancial company, a small portion of its assets is held in the form of cash, defined as demand deposits and currency.

Question 9

Since receivables and payables both result from sales transactions, a firm with a high receivables-to- sales ratio must also have a high payables-to-sales ratio.

Question 10

When deciding whether to offer a discount for cash payment, a firm must balance the profits from additional sales with the lost revenues from the discount.

Question 11

An increase in a current asset must be accompanied by a corresponding increase in a current liability.

Question 12

The credit period is the amount of time it takes to do a credit search on a potential customer.

Question 13

The collection process is a fairly inexpensive component of doing business although sometimes difficult to implement.

Question 14

If a firm has a large percentage of accounts over 30 days old, this is solid proof that its receivables manager is not doing a good job.

Question 15

You receive some goods on April 1 with the following terms: 3/20, net 30, June 1 dating. This means that you will receive a 3% discount if the bill is paid on or before June 20 and also that the full amount must be paid 30 days after receipt of the goods.

Question 16

Lockbox arrangements are one way for a firm to speed up collection of payments from customers.

Question 17

Working capital management deals with the management of current assets and current liabilities such as accounts receivable and accruals, etc.

Question 18

The aging schedule is a commonly used method for monitoring receivables.

Question 19

In addition to being a substitute for cash balances, marketable securities are used as a temporary investment.

Question 20

Providing much higher yields than operating assets, marketable securities are often held in sizable amounts.

Question 21

The EOQ model minimizes total inventory costs.

Question 22

Synchronization of cash flows is an important cash management technique, as it can reduce the required cash balance and increase a firm's profitability.

Question 23

The principal goal of most inventory management systems is to balance the costs of ordering, shipping, and receiving goods against the cost of carrying those goods, while simultaneously meeting the firm's policy with respect to avoiding running short of stock and thus disrupting production schedules or losing sales.

Question 24

Collections float tends to offsets disbursement float. If a firm's average collection float exceeds its average disbursement float, then it is said to be operating with positive net float.

Question 25

If sales are seasonal, the DSO will fluctuate from month to month, even if the amount of time customers take to pay remains unchanged.

Question 26

Cash discounts are mostly used to get new customers in the door since existing customers almost always use the delayed payment terms.

Question 27

The target cash balance should be set so that it need not be adjusted for either seasonal patterns or unanticipated fluctuations, although it should be adjusted to reflect long-term changes in the firm's operations.

Question 28

A JIT system is designed to stretch accounts payable as long as possible.

Question 29

DSO analysis of accounts receivable is the most robust way to see if customers are, on average, paying more slowly, because it is unaffected by seasonal changes in sales.

Question 30

Although firms do not segregate funds for various motives of holding cash, they do consider them in setting their overall cash positions.

Question 31

Cash balances vary widely both among industries and among firms, depending upon specific conditions and on the owners' and financial managers' aversion to risk.

Question 32

Two methods for improving the collection process are the use of a lockbox system and moving funds by electronic transfer.

Question 33

If a company increases its safety stock, then its average inventory will go up.

Question 34

The average collection period is calculated by dividing total sales by accounts receivable. It is an effective measure for internal use in monitoring a firm's collections.

Question 35

The primary reason to monitor aggregate accounts receivable is to see if customers, on average, are paying more slowly.

Question 36

Suppose 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. The average accounts receivable balance will probably decline as a result of this change.

Question 37

Inventory management is largely self-contained in the sense that very little coordination among the sales, purchasing, and production personnel is required for successful inventory management.

Question 38

The overriding goal of inventory management is to ensure that the firm never suffers a stock-out, i.e., never runs out of an inventory item.

Question 39

Outsourcing is a practice of selling a significant percentage of intermediate components to outside suppliers from the in-house productions.

Question 40

Constant demand, constant carrying costs, and constant ordering costs are the three key assumptions of the EOQ model.

Question 41

The addition of a safety stock to the EOQ model increases the EOQ proportionately.

Question 42

If your firm's DSO and/or or aging schedule deteriorates from the first quarter of the year to the second quarter, this is proof positive that your firm's credit policy has weakened.

Question 43

Since a tighter collection policy is very likely to reduce sales, such a change in policy should not be considered.

Question 44

For a nongrowth firm, it is possible to increase the percentage of sales that are made on credit sales and still keep accounts receivable at their current level, provided the firm can shorten the length of its collection period sufficiently.

Question 45

Marketable securities are liquid assets. Holding too low an amount of these liquid assets may
adversely affect a firm's creditworthiness and lower its credit rating, resulting in higher future costs for securing both short- and long-term funds.

Question 46

Decisions on granting credit, or changing credit or collection policies, involve an analysis of the magnitude and timing of the cash flow and the risks and returns expected. This evaluation is done with a net present value framework.

Question 47

Because money has time value, cash sales are always more profitable than credit sales.

Question 48

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.

Question 49

If a firm's sales and those of its customers are closely correlated with economic conditions, it is possible for the firm's total investment in accounts receivable to decline while its DSO increases.

Question 50

When sales rise, inventory as a percentage of sales may also increase even with a computerized inventory control.

Question 51

Changes in a firm's collection policy can affect sales, working capital, and even additional funds needed.

Question 52

A firm on average collects cheques totalling $250,000 per day. It takes the firm approximately 4 days to convert the cheques into usable cash. Assume (1) a lockbox system could be employed that would reduce the cash conversion procedure to 2 1/2 days and (2) the firm could invest any additional cash generated at 6% after taxes. The lockbox system would be a good buy if it costs only $25,000 annually.

Question 53

Depreciation and obsolescence are inventory carrying costs.

Question 54

A lockbox plan is one method of speeding up the cheque-clearing process for customer payments, and as such it decreases the firm's net positive float position.

Question 55

The addition of a safety stock to the EOQ model does not change the total inventory costs.

Question 56

The just-in-time inventory control requires firms to maintain little to no inventory; however, it requires total quality management on all areas of operations.

Question 57

A firm's investment in accounts receivable is largely influenced by production process and the requirements imposed by competition.

Question 58

A firm that makes 90% of its sales on credit and 10% for cash is currently growing at a stable, steady rate of 10% annually. This firm's accounts receivable can be kept at their current level, since the 10% cash sales can be used to support the 10% growth rate.

Question 59

If a firm's terms are 2/10, net 30 days, and its DSO is 28 days, we can be certain that the credit department is functioning efficiently and that the percentage of past due accounts is minimal.

Question 60

Marketable securities aim for long-term investments, but firms may temporarily hold them to convert into cash quickly.

Question 61

If easing a firm's credit policy lengthens the collection period and results in a worsening of the aging schedule, then why might a firm take this action?

A) to slow down an unsustainable growth in sales
B) to meet competitive pressures
C) to increase the payments deferral period
D) to shorten the cash collection cycle

Question 62

Which of the following is NOT correct for a firm with seasonal sales and customers that all pay promptly at the end of 30 days?

A) DSO will vary from month to month.
B) The quarterly uncollected balances schedule will be the same in each quarter.
C) The level of accounts receivable will be constant from month to month.
D) The ratio of accounts receivable to sales will vary from month to month.

Question 63

Which of the following statements best describes float?

A) A lack of synchronization of cash inflows and outflows will result in larger cash balances than would be necessary with better synchronization, but the cash balances can be reduced by increasing disbursement float and decreasing collections float.
B) The size of a firm's net float is primarily a function of its natural cash flow synchronization and how it clears its cheques.
C) Lockbox systems are used both for security purposes and to decrease the firm's net float.
D) If a firm speeds up its collections and slows down its disbursements, this will reduce its net float.

Question 64

The DSO and the aging schedule are two common methods for monitoring receivables. When are they misleading?

A) when customers' payments patterns are changing
B) when sales fluctuate seasonally
C) when some customers take the discount and others do not
D) when sales are relatively constant, both seasonally and cyclically

Question 65

Which of the following statements best describes cash management?

A) A good cash management system minimizes disbursement float and maximizes collections float.
B) If a firm begins to use a well-designed lockbox system, this will reduce its customers' net float.
C) If Firm A can get its suppliers to permit it to pay by wire transfers rather than sending cheques through the mail, this would increase Firm A's net float and thus reduce its investment in cash.
D) A highly efficient cash management system can enable a firm to always have a positive net float, a negative chequebook balance, and still not have its cheques bounce.

Question 66

A lockbox plan is most beneficial to which firms?

A) those with widely disbursed manufacturing facilities
B) those that have a large marketable securities portfolio, and cash, to protect
C) those that hold inventories at many different sites
D) those that have customers who operate in many different parts of the country

Question 67

What is a lockbox plan?

A) It is used for safe-keeping cash and marketable securities.
B) It is used to identify inventory safety stocks.
C) It is used to slow down the collection of cheques a firm writes.
D) It is used to speed up the collection of cheques received.

Question 68

Which of the following is NOT correct?

A) Collection policy is how a firm goes about collecting past-due accounts.
B) A more aggressive collection policy will reduce bad debt expenses, but may also decrease sales.
C) Collection policy usually has little impact on sales since collecting past-due accounts occurs only after the customer has already purchased.
D) Typically, a firm will turn over an account to a collection agency only after it has tried several times on its own to collect the account.

Question 69

Which of the following is NOT a situation that might lead a firm to hold marketable securities?

A) The firm has replaced an obsolete machine with a new model; a large write-off must be taken on the old machine.
B) The firm must meet a known financial commitment, such as financing an ongoing construction project.
C) The firm must finance seasonal operations.
D) The firm has just sold long-term securities and has not yet invested the proceeds in earning assets.

Question 70

Seligstine, Inc.'s DSO was 31 days in March, and 45 days in April. Which of the following is NOT possible?

A) Sales increased from March to April.
B) Sales decreased from March to April.
C) May's quarterly uncollected balances schedule showed a higher percent of April's sales as uncollected than for March.
D) All of the above.

Question 71

Which of the following statements is best describes compensating balances?

A) Compensating balance requirements apply only to businesses, not to individuals.
B) Compensating balances are essentially costless to most firms, because those firms would normally have such funds on hand to meet transactions needs anyway.
C) If the required compensating balance is larger than the transactions balance the firm would ordinarily hold, then the effective cost of any loan requiring such a balance is increased.
D) Banks are prohibited from earning interest on the compensating balances they hold.

Question 72

A firm's credit policy consists of which of the following items?

A) credit period, cash discounts, credit standards, receivables monitoring
B) credit period, cash discounts, credit standards, collection policy
C) credit period, cash discounts, receivables monitoring, collection policy
D) cash discounts, credit standards, receivables monitoring, collection policy

Question 73

Which of the following is NOT commonly regarded as being a credit policy variable?

A) credit period
B) collection policy
C) cash discounts
D) payments deferral period

Question 74

Other things held constant, which of the following will cause an increase in net operating working capital?

A) Cash is used to buy marketable securities.
B) A cash dividend is declared and paid.
C) Merchandise is sold at a profit, but the sale is on credit.
D) Missing inventory is written off against retained earnings.

Question 75

Which of the following is unlikely to be a proper investment for temporarily idle cash?

A) Treasury bills
B) commercial paper
C) recently issued long-term AAA corporate bonds
D) government bonds due within 1 year

Question 76

If the yield curve is upward sloping, then the marketable securities held in a firm's portfolio, assumed to be held for emergencies, should be which of the following?

A) They should consist mainly of long-term securities because those pay higher rates.
B) They should consist mainly of short-term securities because those pay higher rates.
C) They should consist mainly of government securities to minimize interest rate risk.
D) They should consist mainly of short-term securities to minimize interest rate risk.

Question 77

Which of the following statements best describes cash management?

A) A cash management system that minimizes collections float and maximizes disbursement float is better than one with higher collections float and lower disbursement float.
B) A cash management system that maximizes collections float and minimizes disbursement float is better than one with lower collections float and higher disbursement float.
C) The use of a lockbox is designed to minimize cash theft losses in retail stores. If the cost of the lockbox is less than theft losses saved, then the lockbox should be installed.
D) Other things held constant, a firm will need an identical line of credit regardless of whether it must pay its bills by the 5th of each month or pay its bills due uniformly during the month.

Question 78

Which of the following statements is correct?

A) If credit sales as a percentage of a firm's total sales increases, and the volume of credit sales also increases, then the firm's accounts receivable will automatically increase.
B) It is possible for a firm to overstate profits by offering very lenient credit terms that encourage additional sales to financially weak firms. A major disadvantage of such a policy is that it is likely to increase uncollectible accounts.
C) Firms use seasonal dating primarily to decrease their DSO.
D) Seasonal dating with terms 2/15, net 30 days, with April 1 dating, means that if the original sale took place on February 1, the customer can take the discount up until March 15, but must pay the net invoice amount by April 1.

Question 79

Which of the following statements best describes cash balances?

A) Most firms' cash balances consist of transactions and compensating and precautionary balances. The total desired cash balance can be determined by calculating the amount needed for each purpose and then summing them.
B) The easier a firm's access to borrowed funds, the higher its precautionary balances will be in order to protect against sudden increases in interest rates.
C) For some firms, holding highly liquid marketable securities is a substitute for holding cash, because the marketable securities accomplish the same objective as cash.
D) All companies hold the same percentage of funds for transaction balances.

Question 80

Which of the following statements best describes receivables management?

A) A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually. This firm will be able to keep its accounts receivable at the current level, since the 10% cash sales can be used to support the 10% growth rate.
B) In managing a firm's accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady, provided the firm can shorten the length of its collection period (its DSO).
C) If a firm has a high percentage of accounts over 30 days old, this is a sure sign that the credit manager is not doing his or her job well.
D) Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.