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MAS 12 Working Capital Management
Accountancy (San Pedro College)
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ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY
CPA Review Batch 41  May 2021 CPA Licensure Examination  Week No. 14
MANAGEMENT ADVISORY SERVICES
C.P. Lee  E.S Arañas  K.L. Manuel
MAS-12: WORKING CAPITAL MANAGEMENT
WORKING CAPITAL MANAGEMENT (WCM) involves managing the firm’s current assets and current liabilities
to achieve a balance between risks (liquidity) and returns (profitability).

The term ‘working capital’ generally refers to current assets only. For purposes of WCM, ‘working capital’
refers to the difference between current assets and current liabilities (i.e., net working capital):
 The minimum working capital requirement regardless of the seasonal variations in business operations
is called PERMANENT or FIXED working capital.
 When additional working capital is needed during the more active business season, such working capital
is called SEASONAL or VARIABLE or INCREMENTAL working capital.

WORKING CAPITAL FINANCING refers to optimal level, mix and use of current assets and current liabilities.
Consider the following working capital financing policies:
1) CONSERVATIVE financing strategy a.k.a. relaxed policy: a company seeks to minimize liquidity risk by
maintaining a relatively high level of working capital. This policy reduces liquidity risk but is considered
as less profitable due to more reliance on long-term financing that incurs higher financing costs.
2) AGGRESSIVE financing strategy a.k.a. restricted policy: operations are conducted with a minimum
amount of working capital. This policy enhances profitability by relying more on short-term debts rather
than long-term debts but is considered risky due to higher chances of short-term insolvency.
3) MODERATE financing strategy a.k.a. balanced or semi-aggressive or semi-conservative policy: working
capital maintained is relatively not too high (conservative) nor too low (aggressive).
4) MATCHING financing strategy a.k.a. self-liquidating or hedging policy: this policy is achieved by
matching the maturity of financing source with an asset’s useful life (i.e., short-term assets are financed
with short-term liabilities; long-term assets are funded by long-term financing sources).

WCM considers the level, liquidity, activity and structural component of working capital. A sound practice of
WCM would normally involve the following:
 Managing cash and its temporary investment efficiently. (Cash & Marketable Securities Management)
 Drafting and implementing effective credit and collection policies. (Receivable Management)
 Seeking favorable terms from suppliers and other short-term creditors. (Short-Term Credit Financing)
 Ensuring efficient manufacturing operations and sound material procurement. (Inventory Management)
[The topic on ‘Inventory Management’ is well covered in MAS-11 for Week 13]
CASH & MARKETABLE SECURITIES MANAGEMENT

Four (4) reasons for holding cash: “Why would a firm hold cash when, being idle, it is a non-earning asset?”
1) TRANSACTION motive (Liquidity motive): cash is held to facilitate normal transactions of the business.
2) PRECAUTIONARY motive (Contingent motive): cash is held beyond the normal operating requirement to
provide for buffer against contingencies, such as slow-down in collection and possibilities of strikes.
3) SPECULATIVE motive: cash is held to avail of profit-making opportunities (e.g., sudden price drop).
4) CONTRACTUAL motive: cash is held as required by contract provisions (e.g., compensating balance).

OPTIMAL CASH BALANCE (OCB), a.k.a. Economic Cash Quantity or Economic Conversion Size, is based on
the following formula under the BAUMOL model (named after the American economist William Baumol):
Where: D  Annual Demand for Cash
2DT
T  Costs per Transaction
OCB =
O  Opportunity Cost of Holding Cash
O
Opportunity Costs = (OCB ÷ 2) x O
Where: (OCB ÷ 2)  average cash balance
Transaction Costs = (D ÷ OCB) x T
Where: (D ÷ OCB)  number of transaction per year
 “OCB” is the optimal amount of cash to be raised by selling marketable securities or by borrowing
 “D” is total amount of new cash needed for transactions during the year
 “T” refers to the fixed costs of trading securities or cost of borrowing
 “O” refers to the rate of return foregone on marketable securities or the cost of borrowing

The Baumol model, like its pattern EOQ [covered in MAS-10 under inventory management], is based on the
assumption that the demand for cash is spread evenly throughout the year. When there is an irregularity of
cash payment, OCB is computed using another formula based on the MILLER-ORR model where OCB or
‘cash return point’ is achieved when the level of cash reaches an upper limit/maximum amount or a lower
limit/minimum amount.

CASH BREAK-EVEN POINT (BEP) is the sales level at which total cash inflows is equal to total cash outflows.
 Cash BEP in Unit Sales = Fixed Payments ÷ Unit Contribution Margin
 Cash BEP in Peso Sales = Fixed Payments ÷ Contribution Margin Ratio

CASH CONVERSION CYCLE (CCC) a.k.a. cash flow cycle is the average time from the point cash is used to
pay for raw materials until cash is collected on the accounts receivable associated with the goods produced
with those raw materials. CCC must be distinguished from the NORMAL OPERATING CYCLE (NOC), which is
the length of time within which the firm purchases or produces inventory, sells it and receives cash.

NOC = Average Age of Inventory + Average Age of Receivable
CCC = Average Age of Inventory + Average Age of Receivable – Average Age of Payable
(Alternative: CCC = NOC – Average Age of Payable)
Where:
Formula
Other Name(s)
Average Age of Inventory
Inventory ÷ CGS* per day
Inventory Conversion Period, Days Sales in Inventory
Average Age of Receivable
Receivables ÷ Sales per day
Receivable Collection Period, Days Sales Outstanding
Average Age of Payable
Payables ÷ Purchases per day
Payable Deferral Period, Days Payables Outstanding
* “Sales per day” may be used in lieu of CGS per day -- the intention is to use an amount in proportion to unit sales.
‘Average age’ may also be computed using TURNOVER ratios [to be covered in MAS-15 on FS Analysis during Week 18].
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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
MAS-12
Week No. 14: WORKING CAPITAL MANAGEMENT

CASH MANAGEMENT STRATEGIES that help shorten the CCC:
 Accelerating collections (e.g., prompt billing, cash discounts, online collection, lockbox)
 LOCKBOX SYSTEM requires customers to mail payments to a post office box in a specific city, a local
bank then collects the checks from the box and deposit them promptly in the client’s account.
 Reducing precautionary idle cash (e.g., readily available line of credit, well-thought cash budgeting)
 LINE of CREDIT is a predetermined borrowing limit that an entity can use at any time -- the
borrower can take money out as needed until the limit is reached, and as money is repaid, it can be
borrowed again in the case of an open line of credit.
 Slowing disbursements (e.g., payment thru drafts, zero-balance accounts, playing the float)
 ZERO-BALANCE ACCOUNTS (ZBA) requires checks to be written from special disbursement accounts
having zero peso balance with no minimum maintaining balance required. Funds are automatically
transferred from a master account when a check drawn from a ZBA is presented.

FLOAT is the difference between cash balance per BANK and cash balance per BOOK as of a certain period,
primarily due to outstanding checks and other similar reasons. Two types of float are:
 POSITIVE or DISBURSEMENT Float: bank balance > book balance
Possible cause: Outstanding checks issued by the firm that have not cleared yet.
 NEGATIVE or COLLECTION Float: book balance > bank balance
1. MAIL Float – amount of customers’ payments that have been mailed by customers but not yet
received by the seller-company
2. PROCESSING Float – amount of customers’ payments that have been received by the seller but not
yet deposited.
3. CLEARING Float – amount of customers’ checks that have been deposited but have not cleared yet.
NOTE: Good cash management suggests that positive float should be maximized while negative float be
minimized or, if possible, eliminated.

MARKETABLE SECURITIES are short-term money market instruments that can easily be converted to cash.
Some of the common examples where an entity may invest its temporary idle funds:
 CERTIFICATES of DEPOSITS (CD) – savings deposits at financial institutions (e.g., time deposit)
 MONEY MARKET FUNDS – shares in a fund that purchases higher-yielding bank CDs, commercial paper,
and other large-denomination, higher-yielding securities
 GOVERNMENT SECURITIES
 Treasury bills – debt instruments representing obligations of the National Government issued by the
central bank and usually sold at a discount through competitive bidding
 CB Bills or Certificates of Indebtedness (CBCIs) – represent indebtedness by the Central Bank.
 COMMERCIAL PAPERS – short-term, unsecured, material promissory notes issued by private
corporations of very high credit standing.
 REPURCHASE AGREEMENTS (Repos) – investment in loans with a commitment to resell the security at
the original contract price plus an agreed interest income for the holding period.
 BANKERS’ ACCEPTANCES – a draft drawn on a specific bank by a firm that has an account with the
bank, which if accepted by the bank becomes a negotiable instrument and is available for investments.

Factors considered in choosing marketable securities include:
 RISKS
 Default risk – chances that issuer may not be able to pay interest or principal on time.
 Inflation risk – danger that inflation will reduce the investment’s real value.
 Interest rate risk – fluctuations in prices caused by changes in market interest rates.
 MARKETABILITY – refers to how quickly a security can be sold before maturity date without a significant
price concession.
 RETURNS – an entity is willing to assume more risks given a higher expected return on investment.
 TERM or MATURITY – maturity dates should coincide, whenever possible, with the date at which the firm
needs cash, or when the firm will no longer have cash to invest.
 TAXES – some marketable securities do not require payment of taxes, such as municipal bonds.
RECEIVABLES MANAGEMENT

Receivable management refers to the set of policies, procedures, and practices employed by a company
with respect to managing sales on account or credit sales.

Receivable management encompasses the evaluation of customer’s credit worthiness and risk, establishing
sales terms and credit policies, and designing an appropriate receivable collection process.
 CREDIT STANDARD: Which customer will be granted credit? How much is the credit limit? Have we
considered the 5 C’s of Credit?
 Character – customers’ willingness to pay
 Capacity – customers’ ability to generate cash flows
 Capital – customers’ financial sources (i.e., net worth)
 Conditions – current economic or business conditions
 Collateral – customer pledges to secure debt.
 CREDIT TERM refers to the credit period offered to encourage customer sales and discount offered for
customer’s prompt payment. The costs associated with credit terms that must be considered include
cash discounts, credit analysis and collections costs, bad debt losses and financing costs.
 COLLECTION PROGRAM: shortening the average collection period means less investment in receivable
(low opportunity costs) and less chances of delinquency and defaults, but may result to loss of
customers due to less friendly terms.
Meaningful ratios useful in receivable management include receivable turnover, receivable collection period or days
sales outstanding. [These ratios shall be covered in MAS-15 on FS Analysis during Week 18].
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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
MAS-12
Week No. 14: WORKING CAPITAL MANAGEMENT
SHORT-TERM CREDIT FINANCING

Common sources of short-term funds include:
 UNSECURED CREDITS (e.g., accruals, trade credit and commercial papers)
 SECURED LOANS (e.g., receivable financing – pledging and factoring)
(e.g., inventory financing – blanket lien, trust receipts, warehouse receipts)
 BANKING CREDITS (e.g., term loan, line of credit, revolving credit agreement)

Factors considered in selecting sources of short-term funds:
 COST – the effective costs of various credit sources.
 AVAILABILITY – the readiness of credit as to when needed and how much is needed.
 INFLUENCE – the influence of use of one credit source and availability of other sources of financing.
 REQUIREMENT – additional covenants unique to various sources of financing (e.g., loans).

Cost of short-term funds:
 Cost of TRADE CREDIT with supplier*:
Discount Rate
360 Days
COST =
X
100% - Discount Rate
Credit Period - Discount Period
* This type of financing cost is caused by foregoing cash discounts (opportunity cost).
 Cost of BANK LOANS (Effective Annual Rate):
Interest
360 Days
COST =
X
Net Proceeds
Loan Term
 If loan does not require a compensating balance:

Non-discounted: net proceeds = face value

Discounted: net proceeds = face value less interest
 If loan requires a compensating balance (CB):

Non-discounted: net proceeds = face value less CB

Discounted: net proceeds = face value less interest less CB
 Cost of COMMERCIAL PAPERS
Interest + Issue Costs
360 Days
COST =
X
Face value – Interest – Issue Costs
Paper Term
 Cost of FACTORING RECEIVABLES
Interest + Factor’s Fee
360 Days
COST =
X
Face value – Interest – Factor’s Fee – Factor’s Holdback
Remaining Maturity Period
EXERCISES: WORKING CAPITAL MANAGEMENT
1. Working Capital & Liquidity Ratios
Given the partial balance sheet information of Mental Health Support Group Company:
Cash
P 17,000
Accounts Payable
P 10,000
Accounts Receivable
13,000
Accrued Payroll
6,000
Inventory
20,000
Current Tax Liability
4,000
Fixed Assets
70,000
Bonds Payable
30,000
NOTE: Bonds will mature in 10 years.
REQUIRED:
A) Determine the: (1) net working capital (2) current ratio (3) quick or acid-test ratio
B) If the entire accounts payable are paid in cash, what is the new current ratio?
C) If a short-term loan of P 10,000 is obtained from a bank, what is the new current ratio?
2. Working Capital Policy: Conservative vs. Aggressive
MHSG Company has P 1,000,000 in current assets, 40% of which are considered permanent current assets.
In addition, the firm has P 600,000 invested in fixed assets. In the current year, the company reported
earnings of P 200,000 before considering the following interests and tax charges:
 Short-term financing: 5%
 Long-term financing: 10%
 Tax rate: 30%
Plan A – MHSG finances all fixed assets and half of its permanent current assets with long-term financing.
Plan B – MHSG finances all fixed assets and permanent assets plus half of its temporary current assets with
long-term financing.
REQUIRED:
A) How much is the difference in earnings after tax between Plan A and Plan B?
B) Which working capital policy between Plan A and Plan B is considered conservative? aggressive?
3. Optimal Cash Balance – Baumol Model
Suju Corporation is expecting to have total payments of P 1,800,000 for one year, cost per transaction
amounted to P 25, and the interest rate of marketable securities is 10%.
A)
B)
C)
D)
E)
What is the company’s optimal initial cash balance that minimizes total costs?
What is the total number of transactions or cash conversions that will be required per year?
How frequent in days shall Suju Corporation do the transaction or cash conversion within the year?
What will be the average cash balances for the period?
How much is the total cost of maintaining cash balances?
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MAS-12
ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
Week No. 14: WORKING CAPITAL MANAGEMENT
4. Cash Conversion Cycle
Delight Company is concerned about managing cash efficiently. On the average, inventories have an age of
90 days, and accounts receivable are collected in 60 days. Accounts payable are paid approximately 30
days after they arise. Delight spends P 30 million on operating-cycle investments each year, at a constant
rate.
REQUIRED:
A) How long in days is the normal operating cycle?
B) How long in days is the cash conversion cycle?
C) What is the number of cash conversion cycles in one year (360 days)?
D) How much amount of resources is needed to support the cash conversion cycle?
5. Float & Lockbox System
Smirnoff Company has daily cash receipts of P 120,000. A recent analysis of its collection indicated that
customer’s payments were in the mailing system for an average of 3.5 days. Once received, the payments
are processed in 1.5 days. After payments are deposited, it takes an average of 4 days for these receipts
to clear the banking system. Smirnoff considers adopting a lockbox system that will reduce the collection
float time to 6 days. Rate of return is 10%
REQUIRED:
A) How much is the reduction in collection float associated with implementing the lockbox system?
B) If the lockbox system costs P 2,500 per month, should the system be implemented?
C) What maximum amount is Smirnoff Company willing to pay for the lockbox system for one year?
6. Average Investment in Accounts Receivable
Gin Corporation sells on terms of 2/10, n/30. 70% of customers normally avail of the discounts. Annual
sales are P 900,000, 80% of which is made on credit. Cost is approximately 75% of sales.
REQUIRED:
A) Average balance of accounts receivable
B) Average investment in accounts receivable.
7. Collection Policy - Cash Discount
3AM Company presents the following information:

Annual credit sales: P 30,000,000

Collection period: 2 months

Rate of return: 15%
3AM considers changing its credit term from n/30 to 3/10, n/30 to achieve the following results:
(1) 25% of its customers will take advantage of the discount while sales remain constant.
(2) Collection period is expected to decrease from two months to one month.
REQUIRED:
What is the net advantage (disadvantage) of implementing the proposed discount?
8. Credit Policy – Relaxation of Credit Standards & Extension of Credit Period
Red Wristband Corporation reports the following information:
A) Selling price per unit
P 10
B) Variable cost per unit
P8
C) Total fixed costs
P 120,000
D) Annual credit sales
240,000 units
E) Collection period
3 months
F) Rate of return
25%
Red Wristband considers relaxing its credit standards and extending its credit period. The following results
are expected: (1) sales will increase by 25%; (2) collection costs will increase by P 40,000; (3) bad debt
losses are expected to be 5% on the incremental sales; and (4) collection period will increase to 4 months.
REQUIRED:
What is the net advantage (disadvantage) of implementing the relaxation of credit standards and
extension of credit period?
9. SHORT-TERM CREDIT FINANCING
I - COST of TRADE CREDIT
CPL Trading purchases merchandise for P 200,000, 2/10, n/30.
REQUIRED:
A) The annual cost of trade credit.
B) The annual cost of trade credit if term is changed to 1/15, n/20.
II - COST of BANK LOANS
CPL Trading was granted a 180-day P 200,000 bank loan with 12% stated interest.
REQUIRED:
A) CPL
B) CPL
C) CPL
D) CPL
The effective annual rate, under the following cases:
receives the entire amount of P 200,000.
is granted a discounted loan.
is required to maintain a compensating balance of P 10,000 under the non-discounted loan.
is required to maintain a compensating balance of 10% under a discounted loan.
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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
MAS-12
Week No. 14: WORKING CAPITAL MANAGEMENT
III - COST of COMMERCIAL PAPERS
CPL Company plans to sell a 180-day commercial paper amounting to P 100,000,000, which it expects to
pay a discounted interest of 12% per annum. CPL expects to incur P 100,000 in dealer placement fees and
paper issue costs.
REQUIRED:
Determine the effective cost of CPL’s credit.
IV - COST of FACTORING RECEIVABLES
CPL Company has P 200,000 in receivable that carries 30-day credit term, 2% factor’s fee, 6% holdback
reserve and an interest of 12% per annum on advances.
REQUIRED:
A) How much is the cash proceeds from factoring the receivable?
B) What is effective annual rate of financing thru factoring the receivable?
WRAP-UP EXERCISES (MULTIPLE-CHOICE QUESTIONS)
1. Working capital management is concerned about the trade-off between
a. Return and financial risk
b. Default risk and conservatism
c. Current ratio and return on equity
d. Profitability and risk of technical short-term insolvency
2. Which of the following characteristics are generally associated with a CONSERVATIVE financial policy?
a. High current assets relative to sales and high current liabilities relative to total assets
b. High current assets relative to sales and low current liabilities relative to total assets
c. Low current assets relative to sales and high current liabilities relative to total assets
d. Low current assets relative to sales and low current liabilities relative to total assets
3. The PRECAUTIONARY motive for holding cash is for:
a. Daily operating requirements
b. Safety and emergency reasons
c. Compensating balance requirements
d. Buying goods before prices rise to higher levels
4. A working capital technique that increases the payable float and therefore delays the outflow of cash is
a. A draft
c. Electronic fund transfer (EFT)
b. A lockbox system
d. Electronic data interchange (EDI)
5. A firm has an average age in inventory of 90 days, an average collection period of 40 days, and an
average payment period of 30 days. What is the firm’s cash conversion cycle?
a. 70 days
c. 130 days
b. 100 days
d. 160 days
6. An increase in sales resulting from an increased cash discount for prompt payment would be expected
to cause a(n)
a. Increase in the operating cycle
b. Increase in the average collection period
c. Decrease in the cash conversion cycle
d. Decrease in purchase discounts taken
7. Changing a firm’s credit terms from 2/20, net/60 to 2/10, net/30 will generally
a. Increase the average collection period and increase sales
b. Increase the average collection period and reduce sales
c. Decrease the average collection period and increase sales
d. Decrease the average collection period and reduce sales
8. Which of the following forms of short-term borrowing is a secured credit?
a. Line of credit
c. Commercial paper
b. Banker’s acceptances
d. Chattel mortgage
9. Using a 360-day year, what is the opportunity cost to a buyer of not accepting terms 3/10, n/45?
a. 22.27%
c. 55.67%
b. 31.81%
d. 101.73%
10. Sydney Corp. is considering borrowing P 100,000 from a bank for one year at a stated interest rate of
9%. What is the effective interest rate to Sydney if this borrowing is in the form of a discount note?
a. 8.10%
c. 9.81%
b. 9.00%
d. 9.89%
SELF-TEST QUESTIONS – with suggested answers
(Sources: CMA/CIA/RPCPA/AICPA/Various test banks)
1.
C
2.
B
If current assets go up by P 120,000, current liabilities go down by P 50,000, then net working capital
a. Did not change
c. Increased by P 170,000
b. Increased by P 70,000
d. Decreased by P 170,000
Which of the following is strictly not a use of working capital?
a. Repurchase of common stock
c. Purchase of equipment on account
b. Purchase of inventory on account
d. Repayment of long-term debt
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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
MAS-12
Week No. 14: WORKING CAPITAL MANAGEMENT
3.
A
D
B
A
B
D
A
The net working capital of Philippines Company at December 31, 2020 was P 10,000,000. Selected information for the
year 2021 for Philippines Company is as follows:
Working capital provided from operations
P 1,700,000
Capital expenditures
3,000,000
Proceeds from short-term borrowings
1,000,000
Proceeds from long-term borrowings
2,000,000
Payments on short-term borrowings
500,000
Payments on long-term borrowings
600,000
Proceeds from issuance of common stock
1,400,000
Dividends paid on common stock
800,000
What is the net working capital at December 31, 2021?
a. P 10,700,000
c. P 11,500,000
b. P 11,200,000
d. P 12,000,000
4. China Corporation had income before taxes of P 60,000 for the year. Included in this amount was depreciation of P
5,000, a charge of P 6,000 for the amortization of bond discounts, and P 4,000 for interest expense. What is the
estimated cash flow for the period?
a. P 49,000
c. P 66,000
b. P 60,000
d. P 71,000
5. USA Co. has an acid test ratio of 1.5 to 1.0. Which of the following will cause this ratio to deteriorate?
a. Payment of cash dividends previously declared
b. Borrowing short-term loan from a bank
c. Sale of inventory on account
d. Sale of equipment at a loss
6. It is the policy of a company that the current ratio cannot fall below 1.5 to 1.0. Its current liabilities are P 400,000 and
the present current ratio is 2 to 1. How much is the maximum level of new short-term loans it can secure without
violating the policy?
a. P 400,000
c. P 266,667
b. P 300,000
d. P 800,000
7. A firm's current ratio is currently 2.2 to 1. Management knows it cannot violate a working capital restriction contained
in its bond indenture. If the firm's current ratio falls below 2 to 1, technically it will have defaulted. If current liabilities
are P 200,000,000, what is the maximum new commercial paper that can be issued to finance inventory expansion?
a. P 20 million
c. P 180 million
b. P 40 million
d. P 240 million
8. Which one of the following transactions would increase the current ratio and decrease net profit?
a. An income tax payment due from the previous year is paid
b. A stock dividend is declared
c. Uncollectible accounts receivable are written off against the allowance account
d. Vacant land is sold for less than the net book value
9. Which of the following transactions does not change the current ratio and total current assets?
a. A cash advance is made to a divisional office
b. A cash dividend is declared
c. Short-term notes payable are retired with cash
d. A fully depreciated asset is sold for cash
10. Australia Corporation has 100,000 shares of stock outstanding. Below is part of Australia’s Statement of Financial
Position for the last fiscal year.
Statement of Financial Position as of December 31 – Selected items
Cash
P 455,000
Accounts receivable
900,000
Inventory
650,000
Prepaid assets
45,000
Accrued liabilities
285,000
Accounts payable
550,000
Current portion, long-term notes payable
65,000
What is the maximum amount Australia can pay in cash dividends per share and maintain current ratio of 2 to 1?
Assume that all accounts other than cash remain unchanged.
B
a. P 2.05
c. P 3.35
b. P 2.50
d. P 3.80
11. As a company becomes more conservative in working capital policy, it would tend to have a (an)
C
a. Decrease in acid test ratio
b. Increase in the ratio of current liabilities to non-current liabilities
c. Increase in the ratio of current assets to units of output
d. Increase in funds invested in common stock and a decrease in funds invested in securities
12. The firm’s financing requirement can be separated into
A
a. Seasonal and permanent
c. Current liabilities and long-term funds
b. Current assets and fixed assets
d. Current liabilities and long-term debts
13. 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 (where: CA = current assets)
D
a. Temporary CA with long-term debts
c. Permanent CA with long-term debts
b. Fluctuating CA with short-term debts
d. Permanent CA with short-term debts
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Week No. 14: WORKING CAPITAL MANAGEMENT
B
D
D
C
C
B
B
D
A
C
A
C
D
14. Which of the following actions would not be consistent with good working capital management?
a. Increased synchronization of cash flows
b. Minimize the use of float
c. Maintaining an average cash balance equal to that which minimizes total cost
d. Use of checks and drafts in disbursing funds
15. Determining the appropriate level of working capital for a firm requires
a. Evaluating the risks associated with various levels of fixed assets and the types of debt used to
finance these assets
b. Changing the capital structure and dividend policy of the firm
c. Maintaining short-term debt at the lowest possible level because it is generally more expensive than
long-term debt
d. Offsetting the benefit of working capital against the probability of technical insolvency
16. The most direct way to prepare a cash budget for a manufacturing firm is to include
a. Projected sales, credit terms, and net income
b. Projected net income, depreciation and goodwill amortization
c. Projected purchases, percentages of purchases paid, and net income
d. Projected sales and purchases, percentages of collections, and terms of payments
17. Shown below is a forecast of sales for Europe Inc. for the first 4 months of the year (amounts in thousands of pesos).
January
February
March
April
Cash sales
P 15
P 24
P 18
P 14
Sales on credit
100
120
90
70
On average, 50% of credit sales are paid for in the month of sale, 30% in the month following the sale, and the
remainder is paid 2 months after the month of sale. Assuming there are no bad debts, what is the expected cash
inflow for Europe in March?
a. P 138,000
c. P 119,000
b. P 122,000
d. P 108,000
18. Asia Inc. has a pool of cash that it uses to pay bills. When the cash is exhausted, it replenishes its pool by selling Tbills. The firm disburses P 600,000 in cash every year, and every sale of T-bills costs P 60. The current risk-free rate
is 8%. What is the optimal cash balance for Asia?
a. P 27,932
c. P 30,000
b. P 48,530
d. P 37,546
19. A firm needs a total of P 30,000,000 in new cash for transaction purposes. The annual interest rate on marketable
securities is 10% and the brokerage fee cost per transaction of selling securities to replenish cash is P 1,000. Which of
the following is closest to the firm’s optimal average cash balance?
a. P 353,432
c. P 774,597
b. P 387,298
d. P 790,213
20. Africa, Inc. has P 2 million invested in T-bills yielding 8% per annum. This investment will satisfy the firm’s need for
funds during the coming year. It costs P 50 to sell these bills. If Africa needs P 166,667 a month, how frequently
should the company sell off T-bills?
a. About every 3 days
c. About every 15 days
b. About every 9 days
d. About every 18 days
21. A firm has an average age in inventory of 60 days, an average collection period of 45 days, and an average payment
period of 30 days. What is the number of days in the cash flow cycle?
a. 135 days
c. 90 days
b. 105 days
d. 75 days
22. The company’s cash flow cycle extends up to 50 days. Receivables age is for 20 days. Average age in inventory is
twice as long as days’ receivable. For how long is the company’s payable deferral period?
a. 10 days
c. 5 days
b. 20 days
d. 15 days
23. Assume that each day a company writes and receives checks totaling P 10,000. If it takes 5 days for the checks to
clear and be deducted from the company’s account, and only 4 days for the deposits to clear, what is the float?
a. (P 10,000)
c. P 10,000
b. P 0
d. P 50,000
24. Arctic is a retail mail order firm that currently uses a central collection system. An average of 6 days is required for
mailed checks to be received, 3 days for Arctic to process them, and 2 days for the checks to clear through its bank. A
proposed lockbox system would reduce the mailing and processing time to 2 days and the check-clearing time to 1
day. Arctic has an average daily collection of P 150,000. If Arctic adopts the lockbox system, its average cash balance
will increase by
a. P 1,200,000
c. P 600,000
b. P 750,000
d. P 450,000
25. America Company is considering implementing a lockbox system at a cost of P 20,000 per quarter. Annual sales are P
90,000,000, and the lockbox system will reduce collection time by 3 days. If America can invest funds at 8%, should it
implement lockbox system? (Assume a 360-day year)
a. Yes, savings of P 140,000 per year
c. No, loss of P 20,000 per year
b. Yes, savings of P 60,000 per year
d. No, loss of P 60,000 per year
26. A method of delaying the disbursement of cash by a corporation with a liquidity problem would be to:
a. Install a lockbox system
b. Utilize a concentration banking program
c. Take as many cash discounts as possible
d. Pay its bills through the use of bank drafts
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27. A firm has daily cash receipts of P 100,000 and collection time of 2 days. A bank has offered to reduce the collection
time on the firm’s deposit by 2 days for a monthly fee of P 500. If money market rates are expected to average 6%
during the year, the net annual benefit (loss) from having this service is
a. P 0
c. P 6,000
b. P 3,000
d. P 12,000
28. Peru Company is a newly established firm and the owner is deciding what type of checking account to open. Peru is
planning to keep a P 500 minimum balance in the account for emergencies and plans to write roughly 80 checks per
month. The bank charges P 10 per month and P 0.10 per check charge for a standard business checking account with
no minimum balance. Peru also has the option of a premium business balance that requires a P 2,500 minimum
balance but has no monthly fees or per check charges. If cost of funds is 10%, which account should Peru choose?
a. Standard account, because the savings is P 34 per year
b. Premium account, because the savings is P 34 per year
c. Standard account, because the savings is P 16 per year
d. Premium account, because the savings is P 16 per year
29. When managing cash and short-term investments, a corporate treasurer is primarily concerned with
a. Maximizing rate of return
b. Minimizing taxes
c. Investing in treasury bonds since they have no default risk
d. Liquidity and safety
30. Investment instruments used to invest temporarily idle cash balances should have the following characteristics:
a. High expected return, readily marketable, and no maturity date
b. Low default risk, low marketability, and a short term to maturity
c. Low default risk, readily marketable, and a short term to maturity
d. High expected return, low marketability, and a short term to maturity
31. China Inc. has a majority of its customers located in Metro Manila. Tibetan, a major retail bank, has agreed to provide
a lockbox system to China at a fixed fee of P 50,000 per year and a variable fee of P0.50 for each payment processed
by the bank. On average, China receives 50 payments per day, each averaging P 20,000. With the lockbox system,
the company’s collection float will decrease by 2 days. The annual interest rate on money market securities is 6%. If
China makes use of the lockbox system, what would be the net benefit to the company? (Use 365 days per year)
a. P 50,000
c. P 60,875
b. P 59,125
d. P 120,000
32. The primary objective in management of accounts receivable is
a. To achieve that combination of sales volume, bad debt experience, and receivables turnover that
maximizes the profits of the firm
b. To coordinate the activities of manufacturing, marketing, and financing so that the firm can
maximize its profits
c. To provide the treasurer of the corporation with sufficient cash to pay for the bills on time
d. To realize no bad debts because of the opportunity costs involved
33. The average collection period for a firm measures the number of days
a. After a typical credit sale is made until the firm receives the payment
b. For a typical check to ‘clear’ through the banking system
c. Beyond the end of the credit period before a typical customer payment is received
d. Before a typical account becomes delinquent
34. Russia, Inc. sells with terms 3/10, net 30 days. Gross sales for the year are P 2,400,000 and the collections
department estimates that 30% of the customers pay on the tenth day and take discounts; 40% pay on the thirtieth
day; and the remaining 30% pay, on the average, 40 days after the purchase. Assuming 360 days per year, what is
the average collection period?
a. 40 days
c. 20 days
b. 27 days
d. 15 days
35. England Company has an inventory conversion period of 60 days, a receivable conversion period of 35 days, and a
permanent cycle of 26 days. If its sales for the period just ended amounted to P 972,000, what is investment in
accounts receivable? (Assume 360 days in a year)
a. P 72,450
c. P 85,200
b. P 79,600
d. P 94,500
36. Italy sells to retail stores on credit terms of 2/10, n/30. Daily sales average 150 units at a price of P 300 each.
Assuming that all sales are on credit and 60% of its customers take the discount and pay on day 10 while the rest of
the customers pay on day 30, what is the amount of Italy’s accounts receivable?
a. P 1,350,000
c. P 900,000
b. P 990,000
d. P 810,000
37. Mexico Company has the opportunity to increase annual sales by P 1 million by selling to new riskier customers. It has
been estimated that uncollectible expenses would be 15% and collection costs, 5%. The manufacturing and other
selling costs are 70% of sales and corporate tax rate is 35%. What will be effect on the after-tax profit?
a. Increase by P 35,000
c. Increase by P 65,000
b. Increase by P 97,500
d. Remain the same
38. A company’s budgeted sales for the coming year are P 96 million, of which 80% are expected to be credit sales at
terms of n/30. The company estimates that a proposed relaxation of credit standards would increase credit sales by
30% and increase the average collection period from 30 to 45 days. Based on a 360-day year, the proposed relaxation
of credit standards would result to an increase in AR balance by
a. P 6,880,000
c. P 2,880,000
b. P 6,080,000
d. P 1,920,000
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39. Singapore Corporation plans to tighten its credit policy. Below is the summary of changes:
OLD policy
NEW policy
Average number of days collection
75
50
Ratio of credit sales to total sales
70%
60%
Projected sales for the coming year are P 50 million and it is estimated that the company’s credit sales to be 5% less if
the new policy is implemented. Assuming a 360-day year, what is the effect of the new policy on accounts receivable?
a. P 3,333,333 decrease
c. P 6,500,000 decrease
b. P 3,817,445 decrease
d. P 18,749,778 increase
40. Iran Computers believes that is collection costs could be reduced through modification of collection procedures. This
action is expected to result in a lengthening of the average collection period from 28 days to 34 days; however, there
will be no change in uncollectible accounts. The company’s budgeted credit sales for the coming year are P
27,000,000, and short-term interest rates are expected to average 8%. To make the changes in collection procedures
cost beneficial, what would be the minimum savings in collection costs (using a 360-day year) for the coming year?
a. P 30,000
c. P 180,000
b. P 36,000
d. P 360,000
41. A company with P 4.8 million in credit sales per year plans to relax its credit standards, projecting that this will increase
credit sales by P 720,000. The company’s average collection period for new customers is expected to be 75 days, and
the payment behavior of the existing customers is not expected to change. Variable costs are 80% of sales. The
firm’s opportunity cost is 20% before taxes. Assuming a 360-day year, what is the company’s benefit (loss) on the
planned change in credit terms?
a. P 0
c. P 120,000
b. P 28,800
d. P 144,000
42. Based on a 360-day year, what is the current price of P 100 Treasury bill in 180 days on a 6% discount basis?
a. P 100.00
c. P 94.00
b. P 97.00
d. P 93.00
43. The forms of short-term borrowing that are unsecured credit are
a. Floating lien, revolving credit, chattel mortgage, and commercial paper
b. Factoring, chattel mortgage, bankers’ acceptances, and line of credit
c. Floating lien, chattel mortgage, bankers’ acceptances, and line of credit
d. Revolving credit, bankers’ acceptances, line of credit, and commercial paper
44. Sweden Company, a retail store, is considering foregoing sales discounts in order to delay using its cash. Supplier
credit terms are 2/10, n/30. Assuming a 360-day year, what is the annual cost of credit if the cash discount is not
taken and Sweden pays net 30?
a. 24.0%
c. 36.0%
b. 24.5%
d. 36.7%
45. Norway buys on terms of 2/10, net/30, but generally does not pay until 40 days after the invoice date. Its purchases
total P 1,080,000 per year. How much non-free trade credit does the firm use each year?
a. P 120,000
c. P 60,000
b. P 90,000
d. P 30,000
46. Finland plans to acquire an equipment costing P 2,400,000. A bank loan can finance the acquisition with a 10%
discounted interest. Alternatively, the company may delay payment to its suppliers. Presently, the company buys
under terms of 2/10, net 40, but it believes payment could be delayed 30 additional days, without penalty (i.e.,
payment could be made in 70 days). What should the company do?
a. Borrow since it is cheaper by 1.13% than delaying payment to suppliers.
b. Borrow since it is cheaper by 2.5% than delaying payment to suppliers.
c. Delay payments to suppliers since it would cost 12% as against bank loan of 10%.
d. Delay payments to suppliers since it does not cost anything.
47. A compensating balance
a. Compensates a financial institution for services rendered by providing it with fund deposits
b. Is used to compensate for possible losses on a marketable securities portfolio
c. Is a level of inventory held to compensate for variations in usage rate and lead time
d. Is the amount of prepaid interest on a loan
48. Romania Company’s bank requires a compensating balance of 20% on a P 100,000 loan. If the stated interest on the
loan is 7%, what is the effective cost of the loan?
a. 5.83%
c. 8.40%
b. 7.00%
d. 8.75%
49. Belgium Company got a recent quote on a commercial bank loan of 16% discounted rate with a 20% compensating
balance. The term of the loan is one year. What is the effective cost of borrowing?
a. 19.05%
c. 22.85%
b. 20.00%
d. 25.00%
50. A bank loans P 1,000,000 to Ireland for 180 days, with interest of P 60,000 to be paid. The bank also requires a
P200,000 compensating balance for the loan period. What is the effective annual rate?
a. 16.22%
c. 14.00%
b. 15.00%
d. 13.00%
51. Assume that a bank has lent a firm a P 200,000 for 60 days at 10% interest. The loan is discounted, and the bank
requires a 20% compensating balance. What is the effective annual rate?
a. 14.60%
c. 10.17%
b. 12.76%
d. 10.00%
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B
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54. The Brunei Bank and Lugina Corp. signed a loan agreement subject to the following terms:

Stated interest rate of 18% on one-year discounted loan

15% compensating non-interest bearing checking account balance to be maintained by Lugina with Brunei Bank.
The net proceeds of the loan totaled P 1,000,000. What was the principal amount of the loan?
a. P 1,492,537
c. P 1,176,471
b. P 1,219,512
d. P 1,000,000
55. Chile Co. obtained a short-term bank loan for P 250,000 at an annual interest of 6%. Under the loan, the company is
required to maintain a compensating balance of P 50,000 in its savings account that earns interest at an annual rate of
2%. The company would otherwise maintain only P 25,000 in the savings account for transaction purposes. What is
the effective interest rate of the loan?
a. 5.80%
c. 6.66%
b. 6.44%
d. 7.00%
56. A company has accounts payable of P 5 million with terms of 2% discount within 15 days, net 30 days (2/15, n/30). It
can borrow funds from a bank at an annual rate of 12%, or it can wait until the 30th day when it will receive revenues
to cover the payment. If it borrows funds on the last day of the discount period in order to obtain the discount, what
will be its total cost?
a. P 24,500 more
c. P 75,500 less
b. P 51,000 less
d. P 100,000 less
57. Brazil Co. can issue 3-month commercial paper with a face value of P 1,000,000 for P 980,000. The transaction costs
would be P 1,200. What would be the annualized percentage cost of financing?
a. 2.17%
c. 8.48%
b. 8.00%
d. 8.66%
58. A company enters into an agreement with a firm that will factor the company’s accounts receivable. The factor agrees
to buy the receivables, which average P 100,000 per month and have an average collection period of 30 days. The
factor will advance up to 80% of the face value of the receivables at an annual rate of 10% and charge a fee of 2% on
all receivables purchased. The company controller estimates that the company would save P 18,000 in collection
expenses over the year. Fees and interest are not deducted in advance. Based on a 360-day year, what is the annual
cost of financing?
a. 10.0%
c. 14.0%
b. 12.0%
d. 17.5%
59. A firm often factors its accounts receivable. Its finance company requires a 6% reserve and charges a 1.4%
commission on the amount of the receivables. The remaining amount to be advanced is further reduced by an annual
interest charge of 15%. What proceeds will the firm receive from the finance company at the time a P 100,000
account due in 60 days is factored?
a. P 85,000
c. P 92,600
b. P 90,285
d. P 96,135
60. Greece, Inc. plans to factor its receivable and has collected data on the following finance companies:
Required reserves
Commissions
Annual interest charge
Company A
6%
1.4%
15%
Company B
7%
1.2%
12%
Company C
5%
1.7%
20%
Company D
8%
1.0%
5%
Which company will give Greece the highest proceeds from a P 100,000 account due in 60 days?
a. Company A
c. Company C
b. Company B
d. Company D
Solutions and clarifications to selected items
20. Square root of: 2 (2,000,000) 50 ÷ 0.08 = P 50,000
2M ÷ 50,000 = 40 transactions
Frequency of transactions: 360 days ÷ 40 transactions = every 9 days
25. 8% [(90,000,000/360)3] – 20,000 (4) = P 20,000 loss
28. Standard: 500(10%) + 12[10+0.1(80)] = P 266
Premium: 2,500(10%) = P 250
36. Age of AR: 60% (10) + 40% (30) = 18 days
AR = 150 (300) x 18 = P 810,000
39. Old AR balance: 76.8M x (30/360)
New AR balance: (76.8M x 1.3) x (45/360)
40. (27M ÷ 360) x 6 days x 8%
41. Benefit: 720,000 x 20% = P 144,000
Cost: (720,000/360) x 75 days x 80% x 20% = P 24,000
45. Non-free trade credit: (1,080,000 ÷ 360) x (40-10) = P 90,000
46. Loan: 10/90 = 11.1%
Credit: 2/98 x 360/60 = 12.24%
50. 60,000 ÷ (1,000,000 - 200,000) = 7.5%
7.5% (360 ÷ 180) = 15%
Assuming interest is compounded, the effective annual rate (EAR) would have been:
(1 + 7.5%) 360/180 - 1 = 15.56%
NOTE: Unless indicated otherwise, interest is assumed to be non-compounded.
51. Interest = 200,000 x 10% x 60/360 = 3,333
[3,333 ÷ (200,000 – 40,000 – 3,333)] x 360/60 = 12.76%
54. (100% - 18% - 15%) Principal = P 1,000,000
55. [6% (250,000) – 2% (50,000 - 25,000)] ÷ [250,000 - (50,000 - 25,000)] = 6.44%
56. (5M x 98%) x 12% x 15/360 = P 24,500 vs. P 100,000 = 5M x 2 %
58. Interest: 80,000 x 10% x (30/360) = 666.7
Charges: 100,000 x 2% = 2,000
Cost of financing (factoring): {[666.7 + 2,000 - (18,000/12)] ÷ 80,000} x (360 ÷ 30)
59. (100% - 6% - 1.4%) 100,000 – [92,600 (15%) X (60 ÷ 360)]
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