Working Capital Management quiz Financial Accounting Quiz On Mar 30, 2025 Share /10 12345678910 Working Capital Management 10 questions in 15 minutes Pass Score 70% 1 / 10 The working capital financing policy that subjects the firm to the greatest risk of being unable to meet the firm’s maturing obligations is the policy that finances Permanent current assets with long-term debt Fluctuating current assets with long-term debt Fluctuating current assets with short-term debt Permanent current assets with short-term debt Fluctuating current assets can often be financed with short-term debt because the periodic liquidation of the assets provides funds to pay off the debt. However, financing permanent current assets with short-term debt is a risky strategy because the assets may not be liquidated in time to pay off the debt at maturity. 2 / 10 Of the following, the working capital financing policy that would subject a firm to the greatest level of risk is the one where the firm finances Fluctuating current assets with long-term debt Permanent current assets with short-term debt Fluctuating current assets with short-term debt Permanent current assets with long-term debt The maturity matching (self liquidating) approach to financing of current assets minimizes the risk that the entity cannot pay its debts when they become due. It is based on the assumption that the firm can control when the assets are liquidated. Accordingly, the riskiest approach is to finance permanent assets with short-term debt. Moreover, short-term financing subjects the firm to greater risks of interest rate increases and loan renewal problems. 3 / 10 Determining the appropriate level of working capital for a firm requires : Evaluating the risks associated with various levels of fixed assets and the types of debt used to finance these assets Maintaining short-term debt at the lowest possible level because it is ordinarily more expensive than long-term debt Changing the capital structure and dividend policy for the firm Offsetting the profitability of current assets and current liabilities against the probability of technical insolvency A company must maintain a level of working capital sufficient to pay bills as they come due. Failure to do so is technical insolvency and can result in involuntary bankruptcy. Unfortunately, holding current assets for purposes of paying bills is not profitable for a company because they usually offer a low return compared with longer-term investments. Thus, the skillful management of working capital requires a balancing of a firm’s desire for profit with its need for adequate liquidity 4 / 10 C corporation follows an aggressive financing policy in its working capital management while L Corporation follows a conservative financing policy. Which one of the following statements is correct? C has a low ratio of short-term debt to total debt while L has a high ratio of short-term debt to total debt C has a low current ratio while L has a high current ratio C has less liquidity risk while L has more liquidity risk C’s interest charges are lower than L’s interest charges A conservative working capital management financing policy uses permanent capital to finance permanent asset requirements and also some or all of the firm’s seasonal demands. Thus, L’s current ratio (current assets/current liabilities) will be high since its current liabilities will be relatively low. An aggressive policy entails financing some fixed assets and all the current assets with short-term capital. This policy results in a lower current ratio. 5 / 10 A company is experiencing a sharp increase in sales activity and a steady increase in production, so management has adopted an aggressive working capital policy. Therefore, the company’s current level of net working capital Would most likely be lower than under other business conditions in order that the company can maximize profits while minimizing working capital investment Would most likely be higher than under other business conditions as the company’s profits are increasing Would most likely be the same as in any other type of business condition as business cycles tend to balance out over time Would most likely be higher than under other business conditions so that there will be sufficient funds to replenish assets When a firm has an aggressive working capital policy, management keeps the investment in working capital at a minimum. Thus, a growing company would want to invest its funds in capital goods and not in idle assets. This policy maximizes return on investment at the price of the risk of minimal liquidity. 6 / 10 All of the following statements in regard to working capital are true except : Current liabilities are an important source of financing for many small firms Profitability varies inversely with liquidity Financing permanent inventory buildup with long-term debt is an example of an aggressive working capital policy The hedging approach to financing involves matching maturities of debt with specific financing needs Financing permanent inventory buildup, which is essentially a long-term investment, with long-term debt is a moderate or conservative working capital policy. An aggressive policy involves using short-term, relatively low-cost debt to finance the inventory buildup. It focuses on high profitability potential, despite high risk and low liquidity. An aggressive policy involves reducing liquidity and accepting a higher risk of short-term lack of liquidity. Financing inventory with long-term debt increases the current ratio and accepts higher borrowing costs in exchange for greater liquidity and lower risk . 7 / 10 As a company becomes more conservative in its working capital policy, it would tend to have a(n) Increase in funds invested in common stock and a decrease in funds invested in marketable securities Decrease in its acid test ratio Increase in the ratio of current liabilities to noncurrent liabilities Increase in the ratio of current assets to units of output A conservative working capital policy minimizes liquidity risk by increasing net working capital (current assets – current liabilities). The result is that the company forgoes the potentially higher returns available from using the additional working capital to acquire long-term assets. A conservative working capital policy is characterized by a higher current ratio (current assets ÷ current liabilities) and acid test ratio (quick assets ÷ current liabilities). Thus, the company will increase current assets or decrease current liabilities. A conservative policy finances assets using long-term or permanent funds rather than short-term sources . 8 / 10 board of directors has determined 4 options to increase working capital next year. Option 1 is to increase current assets by $120 and decrease current liabilities by $50. Option 2 is to increase current assets by $180 and increase current liabilities by $30. Option 3 is to decrease current assets by $140 and increase current liabilities by $20. Option 4 is to decrease current assets by $100 and decrease current liabilities by $75. Which option should board of directors choose to maximize net working capital? Option 2 Option 4 Option 1 Option 3 Option 1 is correct. Net working capital is the excess of current assets over current liabilities. An increase in current assets or a decrease in current liabilities will increase net working capital. Option 1 maximizes net working capital, increasing it by $170 ($120 + $50). 9 / 10 If a firm increases its cash balance by issuing additional shares of common stock, net working capital Increases and the current ratio decreases Increases and the current ratio increases Remains unchanged and the current ratio remains unchanged Increases and the current ratio remains unchanged Net working capital is the excess of current assets over current liabilities. The current ratio equals current assets divided by current liabilities. Selling stock for cash increases current assets and stockholders’ equity, with no effect on current liabilities. The result is an increase in working capital and the current ratio. 10 / 10 Shown below are selected data from a company’s most recent financial statements: Marketable securities $10,000 Accounts receivable 60,000 Inventory 25,000 Supplies 5,000 Accounts payable 40,000 Short-term debt payable 10,000 Accruals 5,000 What is net working capital? $35,000 $80,000 $45,000 $50,000 Working capital equals current assets minus current liabilities. Assuming the accruals are for expenses, Fortune Company’s calculation is as follows: Marketable securities 10,000 Accounts receivable 60,000 Inventory 25,000 Supplies 5,000 Accounts payable (40,000) Short-term debt payable (10,000) Accruals (5,000) Working capital 45,000 Your score is LinkedIn Facebook Twitter VKontakte 0% Send feedback exam questions on working capital managementQuestion Bank. Working Capital Management.pdfWorking Capital Management
