Cash Management quiz Financial Accounting Quiz On Oct 14, 2024 Share /20 1234567891011121314151617181920 Cash Management 20 questions in 30 minutes Pass Score 70% 1 / 20 A company has daily cash receipts of $150,000. The treasurer of the company has investigated a lockbox service whereby the bank that offers this service will reduce the company’s collection time by four days at a monthly fee of $2,500. If money market rates average 4% during the year, the additional annual income (loss) from using the lockbox service would be : $(6,000) $6,000 $(12,000) $12,000 The additional annual income (loss) from using the lockbox service is the excess (deficit) of interest earned on the accelerated deposits over (under) the cost of theservice. If the plan is adopted, the company’s average cash balance will increase by $600,000 ($150,000 × 4 days). Benefit (loss)= Interest earned – Cost = ($600,000 × 4%) – ($2,500 × 12 months) = $24,000 – $30,000 = $(6,000) 2 / 20 A lockbox system : Accelerates the inflow of funds Provides security for late night deposits Reduces the need for compensating balances Reduces the risk of having checks lost in the mail A lockbox system is one strategy for expediting the receipt of funds. Customers submit their payments to a mailbox controlled by the bank rather than to the company’s offices. Bank personnel remove the envelopes from the mailbox and deposit the checks to the company’s account immediately. The remittance advices must then be transported to the company for entry into the accounts receivable system. The bank generally charges a flat monthly fee for this service. 3 / 20 All of the following are valid reasons for a business to hold cash and marketable securities except to : Meet future needs Maintain adequate cash needed for transactions Earn maximum returns on investment assets Satisfy compensating balance requirements A company will hold cash and marketable securities to facilitate business transactions; cash is a medium of exchange. Cash and near-cash items are also held to meet future needs, to satisfy compensating balance requirements imposed by lenders, and to provide a precautionary balance for security purposes. Cash is usually not held in an attempt to earn maximum returns on investment because cash and marketable securities are not usually the highest paying investments. 4 / 20 Purchases Sales January $150,000 $100,000 February 150,000 200,000 March 150,000 250,000 April 130,000 250,000 May 130,000 300,000 June 100,000 230,000 A cash payment equal to 50% of purchases is made at the time of purchase, and 25% is paid in each of the next 2 months. Purchases for the previous November and December were $140,000 per month. Payroll for a month is 10% of that month’s sales, and other operating expenses are 15% of the following month’s sales (July sales were $210,000). Interest payments were $25,000 paid quarterly in January and April. Cash disbursements for the month of April were: $210,000 $140,000 $130,000 $235,000 Cash disbursements for the month of April are calculated as follows: April purchases: $130,000 × 50% = $ 65,000 March purchases: 150,000 × 25% = 37,500 February purchases: 150,000 × 25% = 37,500 April payroll: 250,000 × 10% = 25,000 April op. expenses: 300,000 × 15% = 45,000 Interest = 25,000 Total April disbursements = $235,000 5 / 20 An entity has received proposals from several banks to establish a lockbox system to speed up receipts. The entity receives an average of 700 checks per day averaging $1,800 each, and its cost of short-term funds is 7% per year. Assuming that all proposals will produce equivalent processing results and using a 360-day year, which one of the following proposals is optimal for the entity? A $0.50 fee per check A compensating balance of $1,750,000 A flat fee of $125,000 per year A fee of 0.03% of the amount collected Multiplying 700 checks times 360 days results in a total of 252,000 checks per year. Accordingly, using a $0.50 fee per check, total annual cost is $126,000 (252,000 × $.50), which is less desirable than a $125,000 flat fee. Given that the annual collections equal $453,600,000 (700 checks × $1,800 × 360 days), a fee of 0.03% of the amount collected is also less desirable because the annual fee would be $136,080 ($453,600,000 × .03%). The best option is therefore to maintain a compensating balance of $1,750,000 when the cost of funds is 7%, resulting in a total cost of $122,500 ($1,750,000 × 7%). 6 / 20 What is the benefit for a firm with daily cash receipts of $15,000 to be able to speed up collections by 2 days, assuming an 8% annual return on short-term investments and no cost to the company to speed up collections? $2,400 annual benefit $30,000 annual benefit $15,000 annual benefit $2,400 daily benefit Speeding up collections by 2 days will raise the firm’s average cash balance by $30,000. At 8% interest, the benefit will be $2,400 annually [($15,000 × 2 days) × .08]. 7 / 20 Average daily collection of checks for a firm is $40,000. The firm also writes on the average $35,000 of checks daily. If the collection period for checks is 5 days, calculate the net float. $200,000 $40,000 $25,000 $175,000 The difference between collections and payables is $5,000 daily. Five days’ worth amounts to $25,000 of float. 8 / 20 The following information applies to B Company: Purchases Sales January $160,000 $100,000 February 160,000 200,000 March 160,000 240,000 April 140,000 300,000 May 140,000 260,000 June 120,000 240,000 A cash payment equal to 40% of purchases is made at the time of purchase, and 30% is paid in each of the next 2 months. Purchases for the previous November and December were $150,000 per month. Payroll is 10% of sales in the month it occurs, and operating expenses are 20% of the following month’s sales (July sales were $220,000). Interest payments were $20,000 paid quarterly in January and April. Cash disbursements for the month of April were : $140,000 $254,000 $200,000 $152,000 Cash disbursements for the month of April are calculated as follows: April purchases: $140,000× 40% = $ 56,000 March purchases: $160,000× 30% = 48,000 February purchases: $160,000× 30% = 48,000 April payroll: $300,000× 10% = 30,000 April op. expenses: $260,000× 20% = 52,000 Interest = 20,000 Total April disbursements = $254,000 9 / 20 The owner of a newly established janitorial firm is deciding what type of checking account to open.The firm is planning to keep a $500 minimum balance in the account for emergencies and plans to write roughly 80 checks per month. The bank charges $10 per month plus a $0.10 per check charge for a standard business checking account with no minimum balance. The firm also has the option of a premium business checking account that requires a $2,500 minimum balance but has no monthly fees or per check charges. If the firm’s cost of funds is 10%, which account should the firm choose? Premium account, because the savings is $34 per year Standard account, because the savings is $34 per year Premium account, because the savings is $16 per year Standard account, because the savings is $16 per year The firm can compare the costs of the two alternatives as follows: Standard account= Variable cost + Fixed cost = [(80 checks × $.10) + $10] × 12 months = $18 × 12 months = $216 per year Premium account = Variable cost + Fixed cost = [$0 + ($2,500 reqd. – $500 projected)] × 10% = $2,000 × 10% = $200 per year Thus, the premium account should be selected because it is cheaper by $16 per year. 10 / 20 A firm has daily cash receipts of $300,000. A commercial bank has offered to reduce the collection time by 2 days. The bank requires a monthly fee of $3,000 for providing this service. If the money market rates will average 11% during the year, the annual pretax income (loss) from using the service is : $(30,000) $30,000 $63,000 $66,000 The additional annual income (loss) from using the bank’s proposed service is the excess (deficit) of interest earned on the early deposits over (under) the cost of the service. If the plan is adopted, the firm’s average cash balance will increase by $600,000 ($300,000 × 2 days). Benefit (loss) = Interest earned – Cost = ($600,000 × 11%) – ($3,000 × 12 months) = $66,000 – $36,000 = $30,000 11 / 20 A firm has daily cash receipts of $100,000 and collection time of 2 days. A bank has offered to reduce the collection time on the firm’s deposits by 2 days for a monthly fee of $500. If money market rates are expected to average 6% during the year, the net annual benefit (loss) from having this service is : $0 $6,000 $12,000 $3,000 The annual benefit (loss) from using the bank’s proposed service is the excess (deficit) of interest earned on the early deposits over (under) the cost of the service. If the plan is adopted, the firm’s average cash balance will increase by $200,000 ($100,000 × 2 days). Benefit (loss) = Interest earned – Cost = ($200,000 × 6%) – ($500 × 12 months) = $12,000 – $6,000 = $6,000 12 / 20 All of the following are reasons for holding cash except for the Transactions motive Motive to make a profit Precautionary motive Motive to meet future needs The three motives for holding cash are : (1) as a medium of exchange (the transactions motive), (2) to provide a reserve for contingencies (the precautionary motive), and (3) to take advantage of unexpected opportunities (the speculative motive). 13 / 20 A retail mail order firm is currently using a central collection system that requires all checks to be sent to its headquarters. An average of 5 days is required for mailed checks to be received, 4 days for the firm to process them, and 1.5 days for the checks to clear through the bank. A proposed lockbox system would reduce the mail and process time to 3 days and the check clearing time to 1 day. The firm has an average daily collection of $100,000. If the firm should adopt the lockbox system, its average cash balance would increase by : $800,000 $400,000 $250,000 $650,000 Checks are currently tied up for 10.5 days (5 for mailing, 4 for processing, and 1.5 for clearing). If that were reduced to 4 days, the firm’s cash balance would increase by $650,000 ($100,000 per day × 6.5 days). 14 / 20 A major bank has agreed to provide a lockbox system to a company at a fixed fee of $50,000 peryear and a variable fee of $0.50 for each payment processed by the bank. On average, the company receives 50 payments per day, each averaging $20,000. With the lockbox system, the company’s collection float will decrease by 2 days. The annual interest rate on money market securities is 6%. If the company makes use of the lockbox system, what would be the net benefit to the company? Use 365 days per year. $60,875 $59,125 $120,000 $50,000 The annual benefit from using the lockbox system is the excess of interest earned on the early deposits over the cost of the service. If the plan is adopted, the firm’s average cash balance will increase by $2,000,000 ($20,000 average payment × 50 per day × 2 days). The annual variable cost will be $9,125 ($.50 per payment × 50 per day × 365 days). Benefit (loss) = Interest earned – Cost = ($2,000,000 × 6%) – ($50,000 + $9,125) = $120,000 – $59,125 = $60,875 15 / 20 A working capital technique that delays the outflow of cash is : Electronic funds transfer A draft Factoring A lockbox system A draft is a three-party instrument in which one person (the drawer) orders a second person (the drawee) to pay money to a third person (the payee). A check is the most common form of draft. It is an instrument payable on demand in which the drawee is a bank. Consequently, a draft can be used to delay the outflow of cash. A draft can be dated on the due date of an invoice and will not be processed by the drawee until that date, thereby eliminating the necessity of writing a check earlier than the due date or using an EFT. Thus, the outflow is delayed until the check clears the drawee bank. 16 / 20 A consultant recommends that a company hold funds for the following two reasons: Reason #1 : Cash needs can fluctuate substantially throughout the year. Reason #2 : Opportunities for buying at a discount may appear during the year. The cash balances used to address the reasons given above are correctly classified as : Reason #1 Reason #2 A Speculative balances Speculative balances B Speculative balances Precautionary balances C Precautionary balances Speculative balances D Precautionary balances Precautionary balances C D A B The three motives for holding cash are as a medium of exchange, as a precautionary measure, and for speculation. Reason #1 can be classified as a precautionary measure, and Reason #2 can be classified as holding cash for speculation. 17 / 20 A firm has daily cash receipts of $200,000. A commercial bank has offered to reduce the collection time by 3 days. The bank requires a monthly fee of $4,000 for providing this service. If money market rates will average 12% during the year, the additional annual income (loss) of having the service is : $(24,000) $66,240 $68,000 $24,000 The additional annual income (loss) from using the bank’s proposed service is the excess (deficit) of interest earned on the early deposits over (under) the cost of the service. If the plan is adopted, the firm’s average cash balance will increase by $600,000 ($200,000 × 3 days). Benefit (loss) = Interest earned – Cost = ($600,000 × 12%) – ($4,000 × 12 months) = $72,000 – $48,000 = $24,000 18 / 20 A compensating balance : Compensates a financial institution for services rendered by providing it with deposits of funds Is the amount of prepaid interest on a loan Is a level of inventory held to compensate for variations in usage rate and lead time Is used to compensate for possible losses on a marketable securities portfolio A compensating balance is a minimum amount that the bank requires the firm to keep in its demand account. Compensating balances are noninterest-bearing and are meant to compensate the bank for various services rendered, such as unlimited check writing. These funds are obviously unavailable for short-term investment and thus incur an opportunity cost. 19 / 20 A firm has daily cash receipts of $300,000 and is interested in acquiring a lockbox service in order to reduce collection time. Bank 1’s lockbox service costs $3,000 per month and will reduce collection time by 3 days. Bank 2’s lockbox service costs $5,000 per month and will reduce collection time by 4 days. Bank 3’s lockbox service costs $500 per month and will reduce collection time by 1 day. Bank 4’s lockbox service costs $1,000 per month and will reduce collection time by 2 days. If money market rates are expected to average 6% during the year, and the firm wishes to maximize income, which bank should the firm choose? Bank 3 Bank 1 Bank 4 Bank 2 The additional annual income generated by Bank 4’s lockbox service can be calculated as follows: Benefit (loss) = Interest earned – Cost = ($300,000 × 2 days × 6%) – ($1,000 × 12 months) = $36,000 – $12,000 = $24,000 20 / 20 Average daily cash outflows are $3 million for firm . A new cash management system can add 2 days to the disbursement schedule. Assuming the firm earns 10% on excess funds, how much should the firm be willing to pay per year for this cash management system? $3,000,000 $1,500,000 $600,000 $6,000,000 If cash outflows are $3 million per day, holding cash 2 extra days means that average balances should increase by $6 million. At a 10% interest rate, the additional $6 million would generate interest revenue of $600,000 per year. Thus, if the system can be acquired for $600,000 or less, it would be beneficial to do so. Your score is LinkedIn Facebook Twitter VKontakte 0% Send feedback Answers to Cash Management Sample Testbest cash management accountbusiness cash management