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) Decrease in the quick ratio Increase in the ratio of current assets to noncurrent assets Decrease in the operating cycle Increase in the ratio of current liabilities to noncurrent liabilities 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 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 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 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. 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 Did not change Increased by $170,000 Decreased 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 company has current assets of $400,000 and current liabilities of $300,000. The company could increase its net working capital by the Prepayment of $50,000 of next year’s rent Acquisition of land valued at $50,000 through the issuance of common stock Refinancing of $50,000 of short-term debt with long-term debt Purchase of $50,000 of trading securities for cash Net working capital is defined as the excess of current assets over current liabilities. Refinancing short-term debt with long-term debt decreases current liabilities with no effect on current assets, resulting in an increase in working capital 5 / 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 3 Option 2 Option 4 Option 1 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). 6 / 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 $230,000 Increase of $10,000 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. 7 / 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 liabilities to noncurrent liabilities Increase in funds invested in common stock and a decrease in funds invested in marketable securities Increase in the ratio of current assets to units of output Decrease in its acid test ratio 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 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 The hedging approach to financing involves matching maturities of debt with specific financing needs Profitability varies inversely with liquidity 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 . 9 / 10 Determining the appropriate level of working capital for a firm requires : 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 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 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 10 / 10 Net working capital is the difference between : Shareholders’ investment and cash Total assets and total liabilities Current assets and current liabilities Fixed assets and fixed 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. Your score is LinkedIn Facebook Twitter VKontakte 0% Send feedback exam questions on working capital managementQuestion Bank. Working Capital Management.pdfWorking Capital Management
