Working Capital Management quiz Managerial Accounting Quiz Share Working Capital Management 10 questions in 15 minutes Pass Score 70% 1 / 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? $45,000 $80,000 $35,000 $50,000 Working capital equals current assets minus current liabilities. Assuming theaccruals 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 2 / 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 Permanent current assets with long-term debt Fluctuating current assets with short-term debt Fluctuating current assets with long-term debt The maturity matching (self liquidating) approach to financing of currentassets minimizes the risk that the entity cannot pay its debts when theybecome due. It is based on the assumption that the firm can control whenthe assets are liquidated. Accordingly, the riskiest approach is to financepermanent assets with short-term debt. Moreover, short-term financingsubjects the firm to greater risks of interest rate increases and loan renewalproblems. 3 / 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. 4 / 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 Increased by $170,000 Decreased by $170,000 Net working capital is the excess of current assets over current liabilities. Anincrease 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 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 Changing the capital structure and dividend policy of the firm Maintaining a high proportion of liquid assets to total assets in order to maximize the return on total investments Offsetting the benefit of current assets and current liabilities against the probability of technical insolvency 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 6 / 10 If a firm increases its cash balance by issuing additional shares of common stock, net working capital Increases and the current ratio decreases Increases and the current ratio increases Remains unchanged and the current ratio remains unchanged Increases and the current ratio remains unchanged Net working capital is the excess of current assets over current liabilities.The current ratio equals current assets divided by current liabilities. Sellingstock for cash increases current assets and stockholders’ equity, with noeffect on current liabilities. The result is an increase in working capital andthe current ratio. 7 / 10 All of the following statements in regard to working capital are true except : Profitability varies inversely with liquidity 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 Current liabilities are an important source of financing for many small firms Financing permanent inventory buildup, which is essentially a long-terminvestment, with long-term debt is a moderate or conservative working capitalpolicy. 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 . 8 / 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 liabilities to noncurrent liabilities Decrease in the operating cycle Decrease in the quick ratio Increase in the ratio of current assets to noncurrent assets A conservative working capital policy results in an increase in workingcapital (current assets – current liabilities). It is typified by a reduction inliquidity risk. Increasing the current ratio, whether by decreasing currentliabilities or increasing current assets, minimizes the risk that the companywill not be able to meet its obligations as they fall due. Thus, an increasingratio of current to noncurrent assets means that a company is forgoing thepotentially higher returns on long-term assets in order to guard againstshort-term cash flow problems. 9 / 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 $230,000 Decrease of $10,000 Increase of $240,000 Increase 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 $ 530,000under the proposal. 10 / 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 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 C has a low current ratio while L has a high current ratio A conservative working capital management financing policy usespermanent capital to finance permanent asset requirements and also someor all of the firm’s seasonal demands. Thus, L’s current ratio (currentassets/current liabilities) will be high since its current liabilities will berelatively low. An aggressive policy entails financing some fixed assetsand all the current assets with short-term capital. This policy results in alower current ratio. Your score is LinkedIn Facebook Twitter VKontakte 0% Send feedback exam questions on working capital managementQuestion Bank. Working Capital Management.pdfWorking Capital Management
