ACCA FM · Chapter 3
Working capital: the cash operating cycle and ratios MCQs with Answers
10 multiple-choice questions on Working capital: the cash operating cycle and ratios for ACCA FM Financial Management. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Extracts from a company's financial statements show: revenue (all on credit) $7,300k, cost of sales $5,110k, inventory $840k, trade receivables $1,200k and trade payables $650k. Payables days are calculated using cost of sales. What is the length of the cash operating cycle, using a 365-day year?
- A) 73.6 days
- B) 87.5 days
- C) 120.0 days
- D) 166.4 days
Show answer & explanation
Answer: A) 73.6 days
Inventory days = 840 / 5,110 x 365 = 60.0; receivables days = 1,200 / 7,300 x 365 = 60.0; payables days = 650 / 5,110 x 365 = 46.4. Cash operating cycle = 60.0 + 60.0 - 46.4 = 73.6 days (rounded to 1 decimal place). Adding payables days, or calculating them on revenue, are common errors.
Question 2
A manufacturer provides the following annual data ($000): purchases of raw materials 2,190, cost of sales 3,650, credit sales 4,380. Year-end balances ($000): raw materials 300, work in progress 220, finished goods 400, trade receivables 600, trade payables 270. Work in progress and finished goods periods are based on cost of sales. What is the cash operating cycle (365-day year)?
- A) 67 days
- B) 95 days
- C) 117 days
- D) 207 days
Show answer & explanation
Answer: C) 117 days
Raw materials period = 300/2,190 x 365 = 50 days; WIP = 220/3,650 x 365 = 22 days; finished goods = 400/3,650 x 365 = 40 days; receivables = 600/4,380 x 365 = 50 days; payables = 270/2,190 x 365 = 45 days. Cycle = 50 + 22 + 40 + 50 - 45 = 117 days (all periods are exact whole days).
Question 3
A company has inventory of $450k, trade receivables of $380k, cash of $70k and current liabilities of $600k. What are its current ratio and quick (acid test) ratio?
- A) Current ratio 1.38; quick ratio 0.63
- B) Current ratio 0.75; quick ratio 1.50
- C) Current ratio 1.50; quick ratio 1.38
- D) Current ratio 1.50; quick ratio 0.75
Show answer & explanation
Answer: D) Current ratio 1.50; quick ratio 0.75
Current ratio = current assets / current liabilities = (450 + 380 + 70) / 600 = 1.50. Quick ratio excludes inventory = (380 + 70) / 600 = 0.75. Ratios are rounded to 2 decimal places.
Question 4
Which of the following is a typical symptom of overtrading?
- A) A rapid increase in revenue accompanied by a sharp rise in the bank overdraft and in payables days
- B) A falling level of revenue with stable working capital
- C) A large cash balance invested in short-term deposits
- D) A very high current ratio caused by excessive inventory and cash
Show answer & explanation
Answer: A) A rapid increase in revenue accompanied by a sharp rise in the bank overdraft and in payables days
Overtrading (undercapitalisation) occurs when a business expands its sales too quickly without enough long-term finance to support the extra working capital. Symptoms include rapid revenue growth, rising inventory and receivables, increasing reliance on the overdraft and trade credit, and falling liquidity ratios. A high current ratio and large cash balances suggest over-capitalisation instead.
Question 5
Why is there said to be a conflict between the two main objectives of working capital management?
- A) Holding more current assets improves liquidity but reduces profitability because of the cost of funding them
- B) Holding more current assets increases both liquidity and profitability
- C) Reducing current assets reduces both liquidity and the risk of insolvency
- D) Liquidity and profitability are unrelated in working capital decisions
Show answer & explanation
Answer: A) Holding more current assets improves liquidity but reduces profitability because of the cost of funding them
The objectives of working capital management are profitability and liquidity. Higher inventories, receivables and cash make it easier to meet obligations as they fall due, but these assets must be financed and generate little or no return, so profitability falls. Lower levels improve profitability but increase liquidity risk.
Question 6
Which of the following, taken on its own, would SHORTEN a company's cash operating cycle?
- A) Allowing customers longer to pay
- B) Paying suppliers early to obtain a settlement discount
- C) Holding higher levels of finished goods inventory
- D) Taking longer to pay trade suppliers
Show answer & explanation
Answer: D) Taking longer to pay trade suppliers
The cash operating cycle equals inventory days plus receivables days less payables days. Increasing payables days therefore reduces the cycle. Longer credit for customers and higher inventory lengthen the cycle, and paying suppliers sooner reduces payables days, which also lengthens the cycle.
Question 7
A company's credit sales for the year were $4.8m and its trade receivables at the year end were $720k. What is the trade receivables collection period, using a 365-day year?
- A) 6.7 days
- B) 7.8 days
- C) 54.0 days
- D) 54.8 days
Show answer & explanation
Answer: D) 54.8 days
Receivables days = trade receivables / credit sales x 365 = 720 / 4,800 x 365 = 54.8 days (rounded to 1 decimal place). The figure of 6.7 is the receivables turnover in times per year, 7.8 is the collection period in weeks rather than days, and 54.0 wrongly uses a 360-day year.
Question 8
A company expects revenue to increase from $10m to $12m next year. Cost of sales is 70% of revenue. It will maintain receivables at 45 days of revenue, inventory at 60 days of cost of sales and trade payables at 40 days of cost of sales. What is the increase in the net investment in working capital (365-day year, to the nearest $)?
- A) $323,288
- B) $476,712
- C) $630,137
- D) $1,939,726
Show answer & explanation
Answer: A) $323,288
Increase in revenue = $2,000,000; increase in cost of sales = $1,400,000. Receivables rise by 2,000,000 x 45/365 = $246,575; inventory by 1,400,000 x 60/365 = $230,137; payables by 1,400,000 x 40/365 = $153,425. Net increase = $246,575 + $230,137 - $153,425 = $323,288 (to the nearest $). $1,939,726 is the total net working capital at the new revenue level, not the increase.
Question 9
A company made credit purchases of $2.92m during the year and its cost of sales was $3.65m. Trade payables were $280k at the start of the year and $360k at the year end. Using year-end payables and credit purchases, what is the trade payables payment period (365-day year)?
- A) 8 days
- B) 36 days
- C) 40 days
- D) 45 days
Show answer & explanation
Answer: D) 45 days
Payables days = year-end trade payables / credit purchases x 365 = 360 / 2,920 x 365 = 45 days (exact). Using cost of sales gives 36 days, using average payables gives 40 days, and 8 is the number of times payables are turned over in a year rather than a number of days.
Question 10
Which of the following is a characteristic of over-capitalisation in working capital?
- A) A current ratio well below the industry average
- B) Rapidly rising sales with a growing bank overdraft
- C) Excessive inventories, receivables and cash leading to a low return on investment
- D) Heavy reliance on extended credit from suppliers
Show answer & explanation
Answer: C) Excessive inventories, receivables and cash leading to a low return on investment
Over-capitalisation means the company holds more working capital than it needs, for example excessive inventory, generous credit to customers or idle cash. Liquidity ratios are high, but the return on capital employed is low because funds are tied up unproductively. The other options are symptoms of overtrading.