Part 9 Working Capital Management
CHAPTER 23
WORKING CAPITAL MANAGEMENT: GENERAL ISSUES
CHAPTER LEARNING OBJECTIVES
23.1 Explain why the management of net working capital is critical for the survival
of a firm.
23.2 Explain how managing receivables, inventory, and payables is related in an
23.3 Explain how financing and current asset investment decisions interact to
23.4 Describe some common ways to analyze a firm’s management of its net
working capital.
Working Capital Management: General Issues 23 – 2
MULTIPLE CHOICE QUESTIONS
1. The correct measure of the cash generating ability of a firm is:
a) Working capital
b) Cash flow from operations
c) Accounts receivable
d) Net income
2. On April 1 Montreal Salsa Dance School had $1,750 in cash, and no receivables or payables.
It also had 100 students whose classes finished on April 30. Thirty-five of those students paid
their tuition of $500 on time (before April 30). During the month the school incurred costs
associated with its operations of instructor salaries $25,000, rent $4,000, and $1,000 utilities. If
the school’s policy of paying all bills in cash at the end of each month is respected, how much
does the school have to borrow to pay its bills?
a) $30,000
b) $12,500
c) $10,750
d) $0
3. On January 1 Joe’s Hardware Store Ltd. had $2,300 in cash, and had neither accounts
receivable nor payable outstanding. During the month of January, the store had received orders
from two contractors for building materials for $20,500, each, which would be paid at the end of
the month. During the month, the store had expenses of $15,500 for salaries, $40,500 for
inventory, and $2,200 of utilities. What would be Joe’s Hardware Store Ltd. cash balance at the
end of the month?
a) –$12,500
b) –$20,400
23 – 3 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
c) $2,400
d) –$14,900
4. Why is a cash budget important?
a) Forecasts cash inflows and outflows
b) Forecasts cash sales
c) Forecasts the impact of cash inflows and outflows on the firm’s cash balances
d) a and c
5. Why do banks require that business loan applications be accompanied by cash budgets?
a) To determine how much cash to loan
b) To determine whether the loan will be a short-term or long-term loan.
c) To determine whether the business will be profitable
d) To calculate the expected return it receives from giving the loan
6. Which of the following is a reason why a very profitable company might go bankrupt?
a) Managers are not forecasting sales correctly
b) Profits do not include the real costs of the business
c) Lack of cash to finance activities
d) Profits are inflated using some accounting method
Working Capital Management: General Issues 23 – 4
7. Which is NOT a part of good working capital management?
a) the maintenance of optimal cash balances
b) the investment of any excess liquid funds in marketable securities that provide the best return
possible, considering any liquidity or default-risk constraints
c) the proper management of accounts receivable
d) the extension of long-term debt
8. Which of the following is NOT a key component of a cash budget?
a) Estimated production schedules
b) Sales forecasts
c) Estimates of the size and timing of other cash inflows and outflows
d) Warranty sales
9. Which of the following is NOT a component of trade credit?
a) Number of days for payment
b) Allows for increased sales levels
c) Invoice indicating the terms of payment
d) The shipping delivery time frame
10. In the event that a business’ cash budget forecasts a cash deficit for a short future period of
time, what should be done?
a) Close the business, as it is unprofitable.
b) Arrange for some short-term borrowing around the expected time of the deficit.
c) Try to make the cash forecast positive by decreasing / cutting costs somehow.
d) Change the credit granting policy of the business.
11. The break-even sales growth rate is defined as:
a) The sales growth rate at which a firm makes profits
b) The sales growth rate of return on a firm’s investment
c) The sales growth rate that makes the monthly cash flow from operations equal zero.
d) The sales growth rate at which investors break even
12. A firm can reduce its burn rate through changing different policies, except:
a) Sales policy by increasing its sales volumes through discount pricing
b) Credit policy by collecting its receivables more quickly
c) Payment policy by delaying the paying of bills
d) Inventory policy by decreasing levels of inventory and having higher inventory rates
13. The break-even sales growth rate is:
a) The sales growth rate that makes the monthly cash flow from operations zero.
b) The internal growth for sales.
c) When sales and inventory growth levels are equal.
d) When accounts receivable and accounts payable payments grow at the sales level.
14. A firm’s payment policy is concerned with
a) When the firm pays its bills
b) How the firm pays its bills (e. g. cheques, electronic fund transfer)
c) Which bills the firm pays
d) All of the above
15. The firm’s cash budget is its:
a) Cash flow statement for each month
b) Amount of cash available for daily sales
c) Cash amount on its balance sheet
d) Foreign currency on hand for foreign trade
16. All of the following are important warning signs indicating potential liquidity problems,
except:
a) build-up of long-term assets
b) decreases in net working capital
c) increases in accounts receivable
d) increase in debt ratios
17. A firm’s inventory policy concerns
a) What the firm does with its inventory
b) What kind of inventory the firm buys
c) The amount of inventory to hold
d) Where the firm holds its inventory
18. A firm’s credit policy concerns
a) what the firm does with its loans
b) what the firm does with its bad debts
c) the amount of inventory to hold
d) when the firm collects its receivables
19. Which one of the following is/are true?
a) The change in cash position is a linear relationship to production.
b) If the sales are lower than the sales growth break-even point, the firm will run out of working
capital.
c) As the level of inventory increases, the required sales growth increases as well.
d) As the level of inventory increases, the required sales growth decreases.
20. Montreal Skaters Corp. collects 10% of its monthly sales immediately and the rest a month
later. Its production costs are 70% of sales. It holds 1 month of sales in inventory, and it pays
half its bills immediately and half after 30 days. What is this firm’s break-even sales growth rate?
a) 78.65%
b) 71.43%
c) 31.58%
d) 10.00%
21. Winnipeg Golf Club Ltd. collects 25% of its monthly sales immediately and the rest of sales
are collected later. Its production costs are 55% of sales. It holds 1 month of inventory, and it
pays 60% of its bills immediately and the rest after 30 days. What is this firm’s break-even sales
growth rate?
a) 71.43%
b) 67.23%
c) 82.54%
d) 57.32%
22. Montreal Skaters Corp. collects 35% of its monthly sales immediately and the rest a month
later. Its production costs are 65% of sales. It holds 1 month of sales in inventory, and it pays
half its bills immediately and half after 30 days. What is this firm’s break-even sales growth rate?
a) 200.0%
b) 46.8%
c) 56.0%
d) 104.0%
23. Which of the following relationships is not true?
a) The break-even sales growth rate is inversely related to the inventory level.
b) The break-even sales growth rate is inversely related to the gross margin.
c) The break-even sales growth rate is inversely related to the payables rate.
d) The break-even sales growth rate is positively related to the collection rate.
24. Cash flow from operations
a) Increases when the collection rate on receivables rises
Working Capital Management: General Issues 23 – 10
b) Increases when the bill payments are made quicker.
c) Decreases when the inventory turnover ratio increases.
d) Increases when the production costs rise.
25. Use the following statements to answer this question:
I. Delaying payment of payables can create a buffer for the firm to keep its working capital.
II. If the firm cannot change its credit, payment, and inventory policies, it has to slow its growth
to survive.
a) I and II are correct.
b) I and II are incorrect.
c) I is correct and II is incorrect.
d) I is incorrect and II is correct.
26. What are two common measures of liquidity?
a) Cash ratio and inventory turnover ratio
b) Receivables turnover ratio and payables turnover ratio
c) Current ratio and quick ratio
d) Inventory turnover ratio and cash conversion rate
27. A good value for the quick ratio is
a) 1
23 – 11 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
b) 1.5
c) 2
d) Varies from industry to industry
28. A good value for the current ratio is:
a) 1.4
b) Varies from industry to industry
c) 1.5
d) 2.0
29. A firm with a high liquidity ratio is definitely practising effective working capital management.
This statement is:
a) True, higher liquidity means that the firm has more cash than it spends.
b) False, higher liquidity means payables are paid much later than receivables and this hurts the
firm’s reputation
c) True, higher liquidity ratio means receivables are greater than payables.
d) False, the firms’ working capital management policy may be too conservative or too lenient
30. The average collection period measures
a) How long it takes the average customer to pay bad debts
Working Capital Management: General Issues 23 – 12
b) How long the firm waits before asking customers to pay
c) How long the firm allows the customers to not pay
d) How long it takes the average customer to pay
31. The manager of your receivables’ department states that the firm’s accounts receivable turn
over 25 times per year. What does this mean?
a) It takes about 25 days, on average, for customers to pay for their orders
b) It takes about 15 days, on average, for customers to pay for their orders
c) It takes about 2 days, on average, for customers to pay for their orders
d) None of the above
32. The inventory turnover ratio is defined as:
a) The ratio of cost of goods sold to sales
b) A ratio measuring the sales that are generated per dollar of receivables
c) A ratio measuring how fast inventory is paid for
d) A ratio of sales to average inventory
33. Why is it better to use sales rather than cost of goods sold when calculating the average
days sales in inventory value?
a) The values for COGS are not always comparable across firms
b) COGS is not the driving variable behind the accumulation of inventory
23 – 13 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
c) Inventory is accumulated regardless of its COGS
d) There are three types of COGS, raw materials, work in progress, and finished goods, and
since all are slightly different, using one or the other would make the calculations inaccurate.
34. Use the following statements to answer this question:
I. The quick ratio is more conservative than the current ratio because it covers a smaller period
of time.
II. The cost of goods sold figure in the inventory turnover ratio is not always reliable because of
the accounting differences used in measuring it.
a) I and II are correct.
b) I and II are incorrect.
c) I is correct and II is incorrect.
d) I is incorrect and II is correct.
35. The payables turnover ratio concerns:
a) Accounts receivable
b) Long-term liabilities
c) Bad debts
d) Accounts payable
36. The operating cycle is defined as:
Working Capital Management: General Issues 23 – 14
a) The amount of time it takes firms to acquire inventory, sell it, and receive payment
b) The amount of time it takes to convert raw materials into finished goods
c) The amount of time it takes to generate profit from operations
d) The amount of time it takes a firm to sell its inventory and receive payment
37. The two components of the operating cycle are:
a) Average days of revenues + average collected payment
b) Average days of revenues in inventory + payables turnover
c) Average days of revenues + average collection period
d) Average days of revenues in inventory + average collection period
38. For a given operating cycle, a firm estimates the amount of financing it requires by
a) Calculating the expected profit from sales over the operating cycle
b) Calculating the total expected sales over the operating cycle
c) Calculating the longest period it can possibly obtain to fulfill its payables
d) Calculating the longest period it can possibly grant for customers’ payables
39. The operating cycle allows firms to estimate
a) the average time between when a firm pays cash for its inventory purchases and when it
receives cash for its sales
b) the average time a firm must keep any borrowed funds
23 – 15 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
c) the average time required for a firm to acquire inventory, sell it, and collect the proceeds
d) the amount of cash a firm needs to be profitable
40. The cash conversion cycle allows firms to calculate
a) The amount of cash they need to operate
b) How long a firm must keep any borrowed funds
c) How long a firm needs to borrow money for
d) The amount of cash a firm needs to be profitable
41. The quick ratio differs from the current ratio in the following way:
a) The current ratio is a more conservative estimate of liquidity compared to the quick ratio
b) The quick ratio excludes both notes payable and bank loans, while the current ratio excludes
only notes payable
c) The quick ratio excludes inventory and prepaid expenses while the current ratio includes all
current assets
d) The quick ratio is generally higher than a firm’s current ratio
42. Firms can grow faster and decrease their cash conversion cycle by doing all of the following
except:
a) Delay paying bills
b) Increase its inventory turnover
Working Capital Management: General Issues 23 – 16
c) Reduce collection time
d) Reduce production costs
43. A company has revenue of $2,043.693 million, accounts receivable of $159.503 million,
average inventory of $71.505 million, and accounts payable of $157.210 million. How many
days are the operating cycle and the cash conversion cycle?
a) 12.77 and 28.49
b) 41.26 and 28.08
c) 41.26 and 13.18
d) 13.18 and 41.26
44. Montreal Bagel Bakery collects 35% of its monthly sales immediately and the rest a month
later. Its production costs are 65% of sales. It holds 1 month of sales in inventory, and it pays
half its bills immediately and half after 30 days. Calculate the operating cycle and the cash
conversion cycle for Montreal Bagel Bakery.
a) 49.5 and 34.5
b) 49.5 and 15
c) 0 and 30
d) 35 and 65
23 – 17 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
PRACTICE PROBLEMS
45. Illustrate and clearly explain how profitable businesses can become bankrupt due to the
mismanagement of their working capital. In your explanation, define what working capital is, along
with its two main components, as well as the difference between cash flow and profits. Finally,
describe how businesses can mitigate this problem of going broke while still being technically
profitable.
46. Explain what the break-even sales growth rate means and what impact it has on the
development of a firm’s operations and credit granting (financial) policy.
47. You recently overheard your boss stating that, “Our company’s high growth rate is making it
difficult for us to keep the business open, and we’re frequently forced to rely on bank loans to
keep us from going bankrupt.” This statement confused you: isn’t a high growth rate a good thing
to have? Clearly explain why or why not and discuss how firms with a problem such as yours
resolve their dilemma.
Working Capital Management: General Issues 23 – 18
48. Montreal Bagel Bakery collects 70% of its monthly sales immediately and the rest a month
later. Its production costs are 65% of sales. It holds 1 month of sales in inventory, and it pays
half its bills immediately and half after 30 days. Calculate the cash conversion cycle and the
operating cycle for Montreal Bagel Bakery.
49. Montreal Bagel Bakery collects 45% of its monthly sales immediately and the rest a month
later. Its production costs are 60% of sales. It holds 1 month of sales in inventory, and it pays
half its bills immediately and half after 30 days. Calculate the cash conversion cycle and the
operating cycle for Montreal Bagel Bakery.
50. Vancouver Sushi Limited collects 35% of its monthly sales immediately and the rest a month
later. Its production costs are 60% of sales. It holds 1 month of sales in inventory, and it pays
60% its bills immediately and 40% after 30 days. Calculate the cash conversion cycle and the
operating cycle for Vancouver Sushi Limited.
Working Capital Management: General Issues 23 – 20
LEGAL NOTICE