True or False (Write “True” if the statement is correct and write “False” if the statement is incorrect)

1. Short-term debt is frequently less expensive because it provides the borrower more security.
2. The hedging principle involves the matching of the cash flow of an asset with the maturity of a financial source.
3. Holding all other variables constant, as account receivables increases, the cash conversion cycle decreases.
4. A firm that continually finances part of its permanent asset needs by short-term financing is following a less-risky
approach.
5. Sources of financing repaid in six months to one year are usually categorized as long-term.
6. Major sources of secured credit include commercial banks, finance companies and factors.
7. Inventory loans are considered an unsecured source of financing.
8. Minimizing working capital is accomplished by slowing down the cash conversion cycle.
9. One factor that determines the amount of cash needed to satisfy a firm’s transaction requirements is the firm’s industry.
10. The speculative motive for holding cash relates to the maintenance of balances to be used to satisfy possible and
indefinite needs.
11. The precautionary motive for holding cash is met to a large extent by the holding of a portfolio of liquid assets, not
just cash.
12. The precautionary motive for holding cash addresses the firm’s desire to take advantage of potential profit-making
situations.
13. Generally, the speculative motive is the least important component of a firm’s preference for liquidity.
14. Many manufacturing firms generate cash on a regular basis through the liquidation of scrap or obsolete inventory.
15. Large cash investments minimize the chance of insolvency and enhance the firm’s profitability.
16. Management of a firm’s liquidity involves management of the firm’s investment in current assets.
17. The minimum level of inventory the firm plans to hold for the foreseeable future is temporary asset investment.
18. The hedging principle involves matching the cash flow from an asset with the cash flow requirements of the financing
used.
19. Current asset investments are always financed with temporary assets.
20. Working capital refers to investment in current assets, while net working capital is the difference between current
assets and current liabilities.
21. The use of current assets subjects the firm to greater liquidity risk due to uncertainty.
22. The use of short-term debt provides flexibility in financing since the firm is only paying interest when it is actually
using the borrowed funds.
23. A firm can reduce net working capital by substituting long-term financing, such as bonds, with short-term financing,
such as one-year notes payable.
24. Notes payable is a spontaneous source of financing.
25. Investing in additional marketable securities and inventories creates higher profitability and lower liquidity.
26. A firm that increases its investment in bonds increases its liquidity.
27. There is a risk-return trade-off involved in managing a firm’s liquidity.
28. Net working capital provides a very useful summary measure of a firm’s short-term financing decisions.
29. Managing a firm’s liquidity is basically the same as managing a firm’s net working capital.
30. Trade credit is a source of spontaneous financing.

Multiple Choices (Write the capital letter (A, B, C or D) of the best answer)

1. Which of the following is most consistent with the hedging principle in working capital management?
a. Fixed assets should be financed with short-term notes payable
b. Inventory should be financed with preferred stock
c. Accounts receivable should be financed with short-term lines of credit
d. Borrow on a floating rate basis to finance investments in permanent assets

2. With regard to the hedging principle, which of the following assets should be financed with permanent sources of
financing?
a. Machinery
b. Expansion of inventory to meet seasonal demands
c. Machinery and expansion of inventory to meet seasonal demands
d. Minimum level of accounts receivable required year round, machinery, and minimum level of cash required for year
round operations

3. Which of the following is a spontaneous source of financing?

a. Accrued wages c. Trade credit
b. Preferred stock d. Both a and c
4. Accounts receivable and inventory self-liquidate through the _______ cycle.
a. Spontaneous account c. Cash conversion
b. Net working capital d. Sales to receivables collection

5. Which of the following is considered a source of spontaneous financing?

a. Trade credit c. Accounts payable
b. Inventories d. Both a and c

6. With regard to the hedging principle, which of the following assets should be financed with current liabilities?
a. Minimum level of cash required for year round operations
b. Expansion of accounts receivable to meet seasonal demands
c. Machinery used to produce a firm’s inventory
d. Both a and b

7. Trade credit is an example of which of the following sources of financing?

a. Spontaneous c. Permanent
b. Temporary d. Both a and b

8. Which of the following is a spontaneous source of financing?

a. Accounts payable
b. Accounts payable and wages and salaries payable
c. Accounts payable and inventories
d. Accounts payable, wages and salaries payable and accrued interest

9. Which of the following types of financing offers the firm the greatest degree of flexibility?
a. Bonds c. Short-term lines of credit
b. Preferred stock d. Long-term notes payable

10. Which of the following actions would improve a firm’s liquidity?

a. Selling stock and reducing accounts payable
b. Selling stock to purchase equipment
c. Selling bonds and purchasing machinery
d. Both a and c

11. The goal of working capital management is to

a. Achieve a balance between a firm’s non-current assets and non-current liabilities
b. Achieve a balance between profitability and risk that contributes positively to a firm’s value
c. Achieve a balance between short-term and long-term assets so that they add to the achievement of a firm’s overall goals
d. Achieve a balance between short-term and long-term liabilities so that they add to the achievement of a firm’s overall
goals

12. A firm can reduce its cash conversion cycle by

a. Increasing the operating cycle
b. Increasing the average age of inventory
c. Increasing the average collection period
d. Increasing the average payment period

13. Other factors remaining constant, an increase in the average payment period will
a. Decrease the operating cycle
b. Not affect the operating cycle
c. Not affect the cash conversion cycle
d. Increase the average collection period

14. A decrease in collection efforts by a firm will result in

_______ in sales volume; _______ in the investment in accounts receivable
_______ in bad debt expenses; _______ in collection expenditures
a. Increase, increase, increase, decrease
b. Increase, decrease, increase, increase
c. Increase, decrease, increase, decrease
d. Decrease, decrease, decrease, increase
15. The aggressive financing is a _______ method while the conservative financing strategy is a _______ method.
a. high-profit, high-risk and low-profit, low-risk
b. low-profit, high-risk and high-profit, low-risk
c. high-profit, low-risk and low-profit, high-risk
d. low-profit, low-risk and high-profit, high-risk

16. Credit management is difficult enough for managers of purely domestic companies, and these tasks become much
more complex for companies that operate internationally
a. This is partly because international operations typically expose a firm to exchange rate risk
b. It is also due to the dangers and delays involved in shipping goods long distances and in having to cross at least two
international borders
c. Both a and b are correct
d. Both a and b are incorrect

17. The following practices or system could extend the cash disbursement, except
a. Lockbox system c. Auto debit transfer
b. Playing the float d. Centralization of disbursement

18. The reason of holding cash that leads to the use of cash balances to take advantage of bargain purchases on materials
or unusual cash discounts.
a. Transaction motive c. Precautionary motive
b. Speculative motive d. All of the above

19. The goal is to minimize the length of the cash conversion cycle, which minimizes negotiated liabilities. This goal can
be realized through use of the following strategies except
a. Turn over inventory as quickly as possible without stockouts that result in lost sales
b. Pay accounts payable as slowly as possible without damaging the firm’s credit rating
c. Collect accounts receivable as quickly as possible without losing sales from high-pressure collection techniques
d. Manage mail, processing, and clearing time to increase them when collecting from customers and to reduce them when
paying supplies

20. The average collection period includes the following

a. The time from the purchase of inventory until the customer mails the payment
b. The time from when the payment is mailed until the firm collected funds in its bank account
c. The time from the payment of inventory purchased until the customer mails the payment
d. None of the above

21. Determining the level of working capital for a firm requires

a. Changing the capital structure and dividend policy of the firm
b. Maintaining short-term debt at the lowest possible level because it is generally more expensive than long-term debt
c. Offsetting the benefit of current assets and current liabilities against the probability of technical insolvency
d. Evaluating the risks associated with various levels of fixed assets and the types of debts used to finance these assets

22. The following are desirable in cash management, except

a. Cash is collected at the earliest time possible
b. All sales are properly receipted and promptly deposited intact
c. Most sales are on cash basis and receivables are aged current
d. Post-dated checks from customers are not deposited on time upon delivery

23. Which of the following actions is likely to reduce the length of a firm’s cash conversion cycle?
a. Reducing the amount of time the firm takes to pay its suppliers
b. Increasing the average days sales outstanding on its accounts receivable
c. Adopting a new inventory system that reduces the inventory conversion period
d. Adopting a new inventory system that increases the inventory conversion period

24. A precautionary motive for holding excess cash is to

a. Enable a company to have cash to meet emergencies that may arise periodically
b. Enable a company to meet cash demands from the normal flow of business activity
c. Enable a company to avail itself of a special inventory purchase before prices rise to higher level
d. Avoid having to use various types of lending arrangements available to cover periodic cash deficits
25. If everything else remains constant and a firm increases its cash conversion cycle, its profitability will likely
a. Increase c. Not be affected
b. Decrease d. Increase if earnings are positive

26. When managing cash and short-term investments, a corporate treasurer is primarily concerned with
a. Minimizing taxes c. Maximizing the rate of return
b. Liquidity and safety d. Investing in treasury bonds since they have no default risk

27. Which of the following is true about a firm’s float?

a. A firm strives to minimize the float for both cash receipts and cash disbursements
b. A firm strives to maximize the float for both cash receipts and cash disbursements
c. A firm strives to minimize the float for cash receipts and maximize the float for cash disbursements
d. A firm strives to maximize the float for cash receipts and minimize the float for cash disbursements

28. Which of the following investments generally pay the highest return?
a. Treasury bills c. Commercial papers
b. Treasury notes d. Money market accounts

29. Which of the following is true about electronic funds transfer from a cash flow standpoint?
a. It is never beneficial from a cash flow standpoint
b. It is always beneficial from a cash flow standpoint
c. It is beneficial from a cash receipts standpoint but not from a cash disbursements standpoint
d. It is beneficial from a cash disbursement standpoint but not from a cash receipts standpoint

30. 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
a. Fluctuating current assets with long-term debt
b. Permanent current assets with long-term debt
c. Fluctuating current assets with short-term debt
d. Permanent current assets with short-term debt

31. Which of the following is not a major function in cash management?

a. Maximizing sales c. Cash surplus investment
b. Cash flow control d. Obtaining financing services

32. All of the following are valid reasons for a business to hold cash and marketable securities, except
a. To meet future needs
b. To satisfy compensating balance requirements
c. To earn maximum returns on investments assets
d. To maintain adequate cash needed for transactions

33. All of the following statements in regard to working capital are correct, except
a. Profitability varies inversely with liquidity
b. Current liabilities are an important source of financing for small firms
c. The hedging approach for financing involves matching maturities of debt with specific financing needs
d. Financing permanent inventory build-up with long-term debt an example of an aggressive working capital policy

34. A lock-box system

a. Accelerates the inflow of funds c. Reduces the need for compensating balances
b. Provides security for late night deposits d. Reduces the risk of having checks lost in the mail

35. Net working capital is the difference between

a. Fixed assets and fixed liabilities c. Shareholders’ investment and cash
b. Total assets and total liabilities d. Current assets and current liabilities