Deck 16: Supply Chains and Working Capital Management

Question 1

Net operating working capital is defined as operating current assets minus operating current liabilities..

Answer 1

True

Question 2

The average accounts receivable balance is a function of both the volume of credit sales and the days sales outstanding.

Answer 2

True

Question 3

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

Answer 3

False

Question 4

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 5

Although short-term interest rates have historically averaged less than long-term rates,the heavy use of short-term debt is considered to be an aggressive current operating asset financing strategy because of the inherent risks of using short-term financing.

Question 6

If a firm takes actions that reduce its days sales outstanding (DSO),then,other things held constant,this will lengthen its cash conversion cycle (CCC).

Question 7

Determining a firm's optimal investment in working capital and deciding how that investment should be financed are critical to working capital management.

Question 8

Net working capital,defined as current assets minus the sum of payables and accruals,is equal to the current ratio minus the quick ratio.

Question 9

Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers.

Question 10

The twin goals of inventory management are (1)to ensure that the inventories needed to sustain operations are available,but (2)to hold the costs of ordering and carrying inventories to the lowest possible level.

Question 11

Shorter-term cash budgets-say a daily cash budget for the next month-are generally used for actual cash control while longer-term cash budgets-say monthly cash budgets for the next year-are generally used for planning purposes.

Question 12

Cash is often referred to as a "non-earning" asset.Thus,one goal of cash management is to minimize the amount of cash necessary for conducting a firm's normal business activities.

Question 13

For a firm that makes heavy use of net float,being able to forecast collections and disbursement check clearings is essential.

Question 14

A conservative current operating asset financing approach will result in permanent current assets and some seasonal current assets being financed using long-term securities.

Question 15

An increase in any current asset must be accompanied by an equal increase in some current liability.

Question 16

Other things held constant,if a firm "stretches" (i.e.,delays paying)its accounts payable,this will lengthen its cash conversion cycle (CCC).

Question 17

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

Question 18

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

Question 19

Net working capital is defined as current assets divided by current liabilities.

Question 20

The concept of permanent current operating assets reflects the fact that some components of current assets do not shrink to zero even when a business is at its seasonal or cyclical low.Thus,permanent current operating assets represent a minimum level of current assets that must be financed.

Question 21

Accruals are "free" capital in the sense that no explicit interest must normally be paid on accrued liabilities.

Question 22

The calculated cost of trade credit for a firm that buys on terms of 2/10 net 30 is lower (other things held constant)if the firm plans to pay in 40 days than in 30 days.

Question 23

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 cost of credit from other sources.

Question 24

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

Question 25

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 26

The facts (1)that no explicit interest is paid on accruals and (2)that the firm can control the level of these accounts at will makes them an attractive source of funding to meet working capital needs.

Question 27

"Stretching" accounts payable is a widely accepted,entirely ethical,and costless financing technique.

Question 28

If a firm busy on terms of 2/10 net 30,it should pay as early as possible during the discount period.

Question 29

Changes in a firm's collection policy can affect sales,working capital,and profits.

Question 30

Funds from short-term loans can generally be obtained faster than from long-term loans for two reasons: (1)when lenders consider long-term loans they must make a more thorough evaluation of the borrower's financial health,and (2)long-term loan agreements are more complex.

Question 31

Trade credit can be separated into two components: free trade credit,which is credit received after the discount period ends,and costly trade credit,which is the cost of discounts not taken.

Question 32

One of the advantages of short-term debt financing is that firms can obtain short-term credit more quickly than long-term credit.

Question 33

If a firm's suppliers stop offering discounts,then its use of trade credit is more likely to increase than to decrease,other things held constant.

Question 34

The calculated cost of trade credit can be reduced by paying late.

Question 35

When deciding whether or not to take a trade discount,the cost of borrowing from a bank or other source should be compared to the cost of trade credit to determine if the cash discount should be taken.

Question 36

Short-term financing is riskier than long-term financing since,during periods of tight credit,the firm may not be able to rollover (renew)its debt.This is especially true if the funds are used to finance long-term assets rather than short-term assets.

Question 37

Accruals are "spontaneous," but unfortunately,due to law and economic forces,firms have little control over the level of these accounts.

Question 38

Short-term marketable securities are held for two separate and distinct purposes: (1)to provide liquidity as a substitute for cash and (2)as a non-operating investment.Marketable securities held while awaiting reinvestment are not available for liquidity purposes.

Question 39

Not taking cash discounts is costly,and as a result,firms that do not take them are usually those that are performing poorly and have inadequate cash balances.

Question 40

One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise,other things held constant.

Question 41

A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality receipts are concentrated at the beginning of each month.

Question 42

A firm that follows an aggressive current asset financing approach uses primarily short-term credit and thus is more exposed to an unexpected increase in interest rates than is a firm that uses long-term capital and thus follows a conservative financing policy.

Question 43

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

Question 44

A promissory note is the document signed when a bank loan is executed,and it specifies financial aspects of the loan.

Question 45

Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e.,after the fact)sense even though it is possible to match maturities on an ex ante (expected)basis.

Question 46

If a firm has set up a revolving credit agreement with a bank,the risk to the firm of being unable to obtain funds when needed is lower than if it had an informal line of credit.

Question 47

Dimon Products' sales are expected to be $5 million this year,with 90% on credit and 10% for cash.Sales are expected to grow at a stable,steady rate of 10% annually in the future.Dimon's accounts receivable balance will remain constant at the current level,because the 10% cash sales can be used to support the 10% growth rate,other things held constant.

Question 48

Since depreciation is a non-cash charge,it neither appears on nor has any effect on the cash budget.Thus,if the depreciation charge for the coming year doubled or halved,this would have no effect on the cash budget.

Question 49

A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality payments are concentrated at the beginning of each month.

Question 50

The cash budget and the capital budget are handled separately,and although they are both important,they are developed completely independently of one another.

Question 51

An informal line of credit and a revolving credit agreement are similar except that the line of credit creates a legal obligation for the bank and thus is a more reliable source of funds for the borrower.

Question 52

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 53

A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the maximum amount of credit the bank will extend to the borrower during some future period,assuming the borrower maintains its financial strength.

Question 54

The relative profitability of a firm that employs an aggressive current asset financing policy will improve if the yield curve changes from upward sloping to downward sloping.

Question 55

Loans from commercial banks generally appear on balance sheets as notes payable.A bank's importance is actually greater than it appears from the dollar amounts shown on balance sheets because banks provide nonspontaneous funds to firms.

Question 56

The longer its customers normally hold inventory,the longer the credit period supplier firms normally offer.Still,suppliers have some flexibility in the credit terms they offer.If a supplier lengthens the credit period offered,this will shorten the customer's cash conversion cycle but lengthen the supplier firm's own CCC.

Question 57

On average,a firm collects checks totaling $250,000 per day.It takes the firm approximately 4 days from the day the checks were mailed until they result in usable cash for the firm.Assume that (1)a lockbox system could be employed which 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 $25,000 annually.

Question 58

The maturity matching,or "self-liquidating," approach to financing involves obtaining the funds for permanent current assets with a combination of long-term capital and short-term capital that varies depending on the level of interest rates.When short-term rates are relatively high,short-term assets will be financed with long-term debt to reduce costs.

Question 59

The maturity of most bank loans is short term.Bank loans to businesses are frequently made as 90-day notes which are often rolled over,or renewed,rather than repaid when they mature.However,if the borrower's financial situation deteriorates,then the bank may refuse to roll over the loan.

Question 60

The cash conversion cycle (CCC)combines three factors: The inventory conversion period,the average collection period,and the payables deferral period,and its purpose is to show how long a firm must finance its working capital.Other things held constant,the shorter the CCC,the more effective the firm's working capital management.

Question 61

Which of the following statements is CORRECT?

A) Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks associated with using short-term financing.
B) If a company follows a policy of "matching maturities," this means that it matches its use of common stock with its use of long-term debt as opposed to short-term debt.
C) Net working capital is defined as current assets minus the sum of payables and accruals, and any decrease in the current ratio automatically indicates that net working capital has decreased.
D) If a company follows a policy of "matching maturities," this means that it matches its use of short-term debt with its use of long-term debt.
E) Net working capital is defined as current assets minus the sum of payables and accruals, and any increase in the current ratio automatically indicates that net working capital has increased.

Question 62

If the yield curve is upward sloping,then short-term debt will be cheaper than long-term debt.Thus,if a firm's CFO expects the yield curve to continue to have an upward slope,this would tend to cause the current ratio to be relatively low,other things held constant.

Question 63

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

A) Collection policy.
B) Credit standards.
C) Cash discounts.
D) Payments deferral period.
E) Credit period.

Question 64

Long-term loan agreements always contain provisions,or covenants,that constrain the firm's future actions.Short-term credit agreements are just as restrictive in order to protect the interest of the lender.

Question 65

If a firm switched from taking trade credit discounts to paying on the net due date,this might cost the firm some money,but such a policy would probably have only a negligible effect on the income statement and no effect whatever on the balance sheet.

Question 66

A lockbox plan is most beneficial to firms that

A) have widely dispersed manufacturing facilities.
B) have a large marketable securities portfolio and cash to protect.
C) receive payments in the form of currency, such as fast food restaurants, rather than in the form of checks.
D) have customers who operate in many different parts of the country.
E) have suppliers who operate in many different parts of the country.

Question 67

A firm constructing a new manufacturing plant and financing it with short-term loans,which are scheduled to be converted to first mortgage bonds when the plant is completed,would want to separate the construction loan from its current liabilities associated with working capital when calculating net working capital.

Question 68

If one of your firm's customers is "stretching" its accounts payable,this may be a nuisance but it does not represent a real financial cost to your firm as long as the customer periodically pays off its entire balance.

Question 69

If a firm sells on terms of 2/10 net 30 days,and its DSO is 28 days,then the fact that the 28-day DSO is less than the 30-day credit period tells us that the credit department is functioning efficiently and there are no past-due accounts.

Question 70

Which of the following actions should Reece Windows take if it wants to reduce its cash conversion cycle?

A) Take steps to reduce the DSO.
B) Start paying its bills sooner, which would reduce the average accounts payable but not affect sales.
C) Sell common stock to retire long-term bonds.
D) Sell an issue of long-term bonds and use the proceeds to buy back some of its common stock.
E) Increase average inventory without increasing sales.

Question 71

Summary balance sheet data for Greener Gardens Co.is shown below (in thousands of dollars).The company is in a highly seasonal business,and the data show its assets and liabilities at peak and off-peak seasons:
From this data we may conclude that

A) Greener Gardens' current asset financing policy is relatively aggressive; that is, the company finances some of its permanent assets with short-term discretionary debt.
B) Greener Gardens follows a relatively conservative approach to current asset financing; that is, some of its short-term needs are met by permanent capital.
C) Without income statement data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy.
D) Without cash flow data, we cannot determine the aggressiveness or conservatism of the company's current asset financing policy.
E) Greener Gardens' current asset financing policy calls for exactly matching asset and liability maturities.

Question 72

If a profitable firm finds that it simply must "stretch" its accounts payable,then this suggests that it is undercapitalized,i.e.,that it needs more working capital to support its operations.

Question 73

The risk to the firm of borrowing using short-term credit is usually greater than if it used long-term debt.Added risk stems from (1)the greater variability of interest costs on short-term than long-term debt and (2)the fact that even if its long-term prospects are good,the firm's lenders may not be willing to renew short-term loans if the firm is temporarily unable to repay those loans.

Question 74

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 75

Which of the following will cause an increase in net working capital,other things held constant?

A) A cash dividend is declared and paid.
B) Merchandise is sold at a profit, but the sale is on credit.
C) Long-term bonds are retired with the proceeds of a preferred stock issue.
D) Missing inventory is written off against retained earnings.
E) Cash is used to buy marketable securities.

Question 76

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

Question 77

Because money has time value,a cash sale is always more profitable than a credit sale.

Question 78

A revolving credit agreement is a formal line of credit.The firm must generally pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.

Question 79

Firms generally choose to finance temporary current operating assets with short-term debt because

A) short-term interest rates have traditionally been more stable than long-term interest rates.
B) a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that borrows short term.
C) the yield curve is normally downward sloping.
D) short-term debt has a higher cost than equity capital.
E) matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less expensive than long-term capital.

Question 80

A lockbox plan is

A) used to identify inventory safety stocks.
B) used to slow down the collection of checks our firm writes.
C) used to speed up the collection of checks received.
D) used primarily by firms where currency is used frequently in transactions, such as fast food restaurants, and less frequently by firms that receive payments as checks.
E) used to protect cash, i.e., to keep it from being stolen.