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 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 Permanent current assets with short-term debt Fluctuating current assets with short-term debt Fluctuating current assets with long-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. 2 / 10 All of the following statements in regard to working capital are true except : The hedging approach to financing involves matching maturities of debt with specific financing needs Financing permanent inventory buildup with long-term debt is an example of an aggressive working capital policy Profitability varies inversely with liquidity Current liabilities are an important source of financing for many small firms 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 . 3 / 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 ) 4 / 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) Decrease of $10,000 Increase of $10,000 Increase of $230,000 Increase of $240,000 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. 5 / 10 If a firm increases its cash balance by issuing additional shares of common stock, net working capital Remains unchanged and the current ratio remains unchanged Increases and the current ratio increases Increases and the current ratio remains unchanged Increases and the current ratio decreases 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. 6 / 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 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 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. 7 / 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 1 Option 3 Option 4 Option 2 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). 8 / 10 Which one of the following would increase the net working capital of a firm? 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 Cash payment of payroll taxes 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. 9 / 10 As a company becomes more conservative in its working capital policy, it would tend to have a(n) Increase in the ratio of current assets to units of output Decrease in its acid test ratio Increase in the ratio of current liabilities to noncurrent liabilities Increase in funds invested in common stock and a decrease in funds invested in marketable securities 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 . 10 / 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 long-term debt Fluctuating current assets with short-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. Your score is LinkedIn Facebook Twitter VKontakte 0% Send feedback exam questions on working capital managementQuestion Bank. Working Capital Management.pdfWorking Capital Management
