Exam Questions

Question 1

Outline your understanding of the working capital cycle

Answer 1

The term working capital cycle refers to the length of time between the purchase of raw materials at the beginning of the production period and the inflow of cash from the sale of goods.

Question 2

Name the key components of working capital management

Answer 2

Cash, Inventory, Receivables, Payables

Question 3

Define Working Capital Management and explain its importance in decision-making.

Answer 3

WC management involves managing a company’s short-term assets and liabilities to ensure efficient operations and financial stability.

Question 4

Conservative working capital approach

Answer 4

Involves maintaining high levels of cash, inventory and receivables, reducing risk, but lowering profitability.

Question 5

Aggressive working capital approach

Answer 5

Minimises working capital to enhance profitability but increasing liquidity risk.

Question 6

Overtrading

Answer 6

Overtrading, also known as undercapitalization, occurs when a business is operating at a level of activity that cannot be supported by the amount of finance that has been committed to the company.

Question 7

Possible causes of overtrading

Answer 7

New, expanding business that fail to prepare adequately for rapid increases in the demand for goods and services].
As a result of inflation, causing the need for more finance to be committed to stock and trade receivables].
When the owners of the business are unable to inject further funds into the business and/or cannot persuade others to invest in the business.

Question 8

How would you recognise signs of overtrading in the financiall information?

Answer 8

Rapid increase in turnover over short period of time].
Increase in current assets is financed by credit, such as, trade creditors and bank overdraft].
Debt and liquidity ratios alter dramatically].

Question 9

How can shareholders be rewarded (dividend-wise)?

Answer 9

A cash dividend - the company can distribute profits by paying a cash dividend].

Capital gain - If a firm continues to reinvest profits into a project with positive NPV’s then the share price of the company may rise. Shareholders will then make capital gains].

Scrip dividends - Shareholders can be rewarded with extra shares.

Question 10

Briefly explain what the term ‘factoring’ means.

Answer 10

Debt factoring is when a company sells its invoices to a third party at a discount. This is done in exchange for an advance of cash. Debt factoring allows companies to access capital that’s tied up in unpaid invoices.

Question 11

Outline 2 non-financial factors that should be considered when deciding if a factoring service should be availed of.

Answer 11

Loss of control over invoice collection - When a factoring company takes over invoice collections, the business loses control over the contacting of customer, which may damage a business’s reputation].

Loss of confidentiality - Factoring service would be given a certain amount of control over the sales ledger, resulting in a loss of confidentiality].

Question 12

Shareholder theory

Answer 12

The shareholder theory is the view that the only duty of a company is to maximise the wealth of the shareholders.

Question 13

Stakeholder theory

Answer 13

The stakeholder theory is the view that all stakeholders are equally important and their needs/wants must be considered.

Question 14

Describe the 3 main reasons why firms hold inventory

Answer 14

Transaction motive - Day-to-day transactions.

Precautionary motive - Uncertain future cash flows.

Speculative motive - to avail of unexpected opportunities.

Question 15

Buffer inventory

Answer 15

Extra inventory that is held in case of a problem or an emergency.

Question 16

Lead Time

Answer 16

The length of time between placing an order and receiving the goods.