Working Capital Management quiz Financial Accounting Quiz On Oct 12, 2024 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) 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 Decrease in the operating cycle 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 A corporation is considering a plant expansion that will increase its sales and net income. The following data represent management’s estimate of the impact the proposal will have on the company: Current Proposed Cash $ 120,000 $ 140,000 Accounts payable 360,000 450,000 Accounts receivable 400,000 550,000 Inventory 360,000 420,000 Marketable securities 180,000 180,000 Mortgage payable (current) 160,000 310,000 Fixed assets 2,300,000 3,200,000 Net income 400,000 550,000 The effect of the plant expansion on net working capital will be a(n) Increase of $240,000 Increase of $10,000 Increase of $230,000 Decrease of $10,000 Net working capital is defined as current assets minus current liabilities. Net working capital is calculated as follows: Current Proposed Cash $120,000 $140,000 Accounts receivable 400,000 550,000 Inventory 360,000 420,000 Marketable securities 180,000 180,000 Total current assets $1,060,000 $1,290,000 Accounts payable $360,000 $450,000 Mortgage payable -- current 160,000 310,000 Total current liabilities $ (520,000 ) $ (760,000 ) Working capital $ 540,000 $ 530,000 Net working capital decreases by $10,000 from the current $ 540,000 to $ 530,000 under the proposal. 3 / 10 Which one of the following would increase the net working capital of a firm? Cash payment of payroll taxes payable Purchase of a new plant financed by a 20 year mortgage Cash collection of accounts receivable Refinancing a short-term note payable with a 2 year note payable 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. 4 / 10 During the year, Company’s current assets increased by $120,000, current liabilities decreased by $50,000, and net working capital Increased by $70,000 Decreased by $170,000 Did not change 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 ) 5 / 10 Net working capital is the difference between : Current assets and current liabilities Fixed assets and fixed liabilities Shareholders’ investment and cash Total assets and total liabilities Net working capital is defined by accountants as the difference between current assets and current liabilities. Working capital is a measure of shortterm solvency. 6 / 10 Determining the appropriate level of working capital for a firm requires : Offsetting the benefit of current assets and current liabilities against the probability of technical insolvency Maintaining a high proportion of liquid assets to total assets in order to maximize the return on total investments Changing the capital structure and dividend policy of the firm Maintaining short-term debt at the lowest possible level because it is generally more expensive than long-term debt 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 7 / 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 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 higher than under other business conditions as the company’s profits are increasing 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. 8 / 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’s interest charges are lower than L’s interest charges C has less liquidity risk while L has more liquidity risk C has a low current ratio while L has a high current ratio 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 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. 9 / 10 Determining the appropriate level of working capital for a firm requires : Offsetting the profitability of current assets and current liabilities against the probability of technical insolvency Maintaining short-term debt at the lowest possible level because it is ordinarily more expensive than long-term debt Evaluating the risks associated with various levels of fixed assets and the types of debt used to finance these assets Changing the capital structure and dividend policy for the firm 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 10 / 10 All of the following statements in regard to working capital are true except : Financing permanent inventory buildup with long-term debt is an example of an aggressive working capital policy Current liabilities are an important source of financing for many small firms Profitability varies inversely with liquidity 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 . Your score is LinkedIn Facebook Twitter VKontakte 0% Send feedback exam questions on working capital managementQuestion Bank. Working Capital Management.pdfWorking Capital Management
