Chapter Review
Questions
6. a. A receivable is generated when product is shipped reflecting the fact that a sale has been made.
Building the product, however, requires cash that isn't recovered until the receivable is collected.
Therefore, receivables require funding.
b. Cash is money in the bank available to pay bills and transact business.
That money has to be
deposited and therefore represents an asset just like a machine or an inventory item.
In effect, the firm
"buys" an account balance at the bank.
Therefore cash requires financing.
It certainly doesn't reduce
the need for financing.
7. A business's operating cycle begins with the purchase of inventory that in time is turned into product
and sold.
The sale results in a receivable that becomes cash when collected.
The cash is used to
purchase more inventory at the start of the cycle again.
The term operating cycle refers to both the
sequence of events and the time required to go through it once.
The cash conversion cycle is the
operating cycle in days less the payables deferral period, which is the time between receiving and paying
for inventory.
10. Working capital can be financed by either short- or long-term funds.
Short-term money is always
borrowed while long-term funds can be either debt or equity.
Short-term financing is usually cheaper
(lower interest) but has to be renewed periodically as loans become due for repayment.
This means a
strategy of supporting working capital with short-term borrowing requires a continuous series of new
loans. This creates a risk, because short rates do sometimes exceed long rates.
Worse, situations
occasionally occur in which refinancing isn't available at any rate.
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- Spring '14
- DavidM.Neipert
