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 As a company becomes more conservative with respect to working capital policy, it would tend to have a(n) Decrease in the operating cycle Increase in the ratio of current assets to noncurrent assets Increase in the ratio of current liabilities to noncurrent liabilities Decrease in the quick ratio A conservative working capital policy results in an increase in working capital (current assets – current liabilities). It is typified by a reduction in liquidity risk. Increasing the current ratio, whether by decreasing current liabilities or increasing current assets, minimizes the risk that the company will not be able to meet its obligations as they fall due. Thus, an increasing ratio of current to noncurrent assets means that a company is forgoing the potentially higher returns on long-term assets in order to guard against short-term cash flow problems. 2 / 10 Which one of the following would increase the net working capital of a firm? Cash payment of payroll taxes payable Cash collection of accounts receivable Refinancing a short-term note payable with a 2 year note payable Purchase of a new plant financed by a 20 year mortgage Net working capital equals current assets minus current liabilities. Refinancing a short-term note with a 2 year note payable decreases current liabilities, thus increasing working capital. 3 / 10 Determining the appropriate level of working capital for a firm requires : 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 Evaluating the risks associated with various levels of fixed assets and the types of debt used to finance these assets 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 Determining the appropriate level of working capital for a firm requires : Maintaining a high proportion of liquid assets to total assets in order to maximize the return on total investments Maintaining short-term debt at the lowest possible level because it is generally more expensive than long-term debt Offsetting the benefit of current assets and current liabilities against the probability of technical insolvency Changing the capital structure and dividend policy of the firm Working capital finance concerns the determination of the optimal level, mix, and use of current assets and current liabilities. The objective is to minimize the cost of maintaining liquidity while guarding against the possibility of technical insolvency. Technical insolvency is defined as the inability to pay debts as they come due 5 / 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 current ratio while L has a high current ratio C’s interest charges are lower than L’s interest charges 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 less liquidity risk while L has more liquidity risk 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. 6 / 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 $45,000 $50,000 $80,000 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 7 / 10 During the year, Company’s current assets increased by $120,000, current liabilities decreased by $50,000, and net working capital Did not change Increased by $70,000 Decreased by $170,000 Increased by $170,000 Net working capital is the excess of current assets over current liabilities. An increase in current assets or a decrease in current liabilities increases working capital. Thus, net working capital increased by $170,000 ($120,000 + $50,000 ) 8 / 10 Net working capital is the difference between : Total assets and total liabilities Current assets and current liabilities Fixed assets and fixed liabilities Shareholders’ investment and cash Net working capital is defined by accountants as the difference between current assets and current liabilities. Working capital is a measure of shortterm solvency. 9 / 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 Fluctuating current assets with short-term debt Fluctuating current assets with long-term debt Permanent current assets with short-term debt Permanent current assets with long-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. 10 / 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 higher than under other business conditions as the company’s profits are increasing Would most likely be higher than under other business conditions so that there will be sufficient funds to replenish assets 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 lower than under other business conditions in order that the company can maximize profits while minimizing working capital investment 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. Your score is LinkedIn Facebook Twitter VKontakte 0% Send feedback exam questions on working capital managementQuestion Bank. 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