Financial Ratios
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CPA Auditing and Attestation (AUD) › Financial Ratios
When a firm finances each asset with a financial instrument of the same approximate maturity as the life of the asset, it is applying:
Operating leverage
Financial leverage
Return maximization
Working capital management
Explanation
Working capital management matches the maturity life of each asset with the length of the financial instrument used to finance that asset.
If a firm increases its cash balance by issuing additional shares of common stock, 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
Explanation
An increase in cash balance by issuing more common stock would increase assets and equity, thus increasing working capital and current ratio.
The main reason that a firm would strive to reduce the days sales in accounts receivable is to increase:
Accounts receivable
Contribution margin
Cash
Cost of good sold
Reducing the A/R cycle increases cash collected and on hand.
Explanation
Reducing the A/R cycle increases cash collected and on hand.
Which of the following would increase the working capital of a firm?
Purchase of a new plant financed by a 20 year mortgage
Refinancing a short term note payable with a two year note payable
Cash collection of A/R
Payment of a 20 year mortgage payable with cash
Explanation
This answer would increase the working capital of a firm as the amount of this current liability is transferred to a long term liability.
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:
Fluctuating current assets with long term debt
Permanent current assets with long term debt
Permanent current assets with short term debt
Fluctuating current assets with short term debt
Explanation
The working capital financing policy that finances permanent current assets with short term debt subjects the firm to the greatest risk of being unable to meet the firm's maturing obligations.
Fewer days sales in accounts receivable are:
Ideal
Ideal as long as the company does not lose too many sales
Not ideal
Irrelevant
Explanation
Reducing the number of days it takes to collect cash is ideal for a company, as long as it does not reduce the number of sales to customers. Customers may not like this shortened receivable policy.