AFP Liquidity Management 1 — Questions and Answers
Question 1: Which of the following best defines liquidity in the context of corporate treasury management?
- The total market value of a company's equity shares
- The ability to meet short-term financial obligations as they come due (Correct answer)
- The ratio of long-term debt to total assets
- The profitability generated from operating activities
Correct answer: The ability to meet short-term financial obligations as they come due
Liquidity refers to a company's ability to meet short-term financial obligations on time using available cash or assets that can be quickly converted to cash.
Question 2: The current ratio is calculated as:
- Net income divided by total assets
- Current assets divided by current liabilities (Correct answer)
- Total debt divided by shareholders' equity
- Operating cash flow divided by net sales
Correct answer: Current assets divided by current liabilities
The current ratio equals current assets divided by current liabilities, measuring a company's ability to cover short-term obligations with short-term assets.
Question 3: A quick ratio (acid-test ratio) differs from the current ratio in that it:
- Includes long-term investments in the numerator
- Excludes inventory and prepaid expenses from current assets (Correct answer)
- Uses total liabilities instead of current liabilities in the denominator
- Adds back depreciation to the numerator
Correct answer: Excludes inventory and prepaid expenses from current assets
The quick ratio excludes inventory and prepaid expenses from current assets because these items are less liquid and cannot be quickly converted to cash.
Question 4: Which liquidity management strategy involves concentrating subsidiary cash balances into a single master account?
- Netting
- Cash pooling (Correct answer)
- Factoring
- Dynamic discounting
Correct answer: Cash pooling
Cash pooling consolidates cash balances from multiple subsidiary or regional accounts into a single master account, optimizing interest income and reducing borrowing costs.
Question 5: The cash conversion cycle (CCC) measures:
- The time from raw material purchase to collection of cash from customers (Correct answer)
- The number of days to convert long-term assets to cash
- The speed at which a company converts equity to debt
- The interval between dividend payments and earnings reports
Correct answer: The time from raw material purchase to collection of cash from customers
The CCC measures the time elapsed from paying for raw materials to receiving cash from customers, encompassing DIO + DSO – DPO.
Question 6: Which of the following is a primary source of short-term liquidity for most corporations?
- Issuance of 30-year bonds
- Revolving credit facility (Correct answer)
- Initial public offering of common stock
- Sale-leaseback of real estate
Correct answer: Revolving credit facility
A revolving credit facility is the most common short-term liquidity backstop, allowing companies to draw and repay funds repeatedly up to a credit limit.
Question 7: Days Payable Outstanding (DPO) is calculated as:
- Accounts receivable divided by daily sales
- Accounts payable divided by daily cost of goods sold (Correct answer)
- Inventory divided by daily cost of goods sold
- Net income divided by daily revenue
Correct answer: Accounts payable divided by daily cost of goods sold
DPO equals accounts payable divided by daily cost of goods sold, indicating how long a company takes to pay its suppliers.
AFP Liquidity Management 1
Which of the following best defines liquidity in the context of corporate treasury management?