FAC Cash Flow Management 3 — Questions and Answers
Question 1: What is the primary purpose of a cash budget in cash flow management?
- To record historical cash transactions
- To forecast future cash inflows and outflows over a period (Correct answer)
- To comply with GAAP reporting requirements
- To calculate net income for tax purposes
Correct answer: To forecast future cash inflows and outflows over a period
A cash budget projects expected cash receipts and disbursements to help management plan for surpluses and shortfalls.
Question 2: Which scenario describes a cash flow problem even when a business is profitable?
- Revenue exceeds expenses for the period
- Customers pay invoices faster than expected
- High sales growth leads to large increases in accounts receivable (Correct answer)
- Depreciation expense reduces taxable income
Correct answer: High sales growth leads to large increases in accounts receivable
Rapid revenue growth can create a cash crunch if receivables grow faster than collections, a common cause of business failure.
Question 3: Which of the following is an example of a financing activity on the cash flow statement?
- Purchase of machinery
- Collection of accounts receivable
- Repayment of a long-term loan (Correct answer)
- Payment of wages to employees
Correct answer: Repayment of a long-term loan
Repayment of long-term debt is a financing activity because it relates to the company's capital structure.
Question 4: The cash conversion cycle (CCC) is best defined as:
- Days sales outstanding minus days payable outstanding
- Days inventory outstanding plus days sales outstanding minus days payable outstanding (Correct answer)
- Days payable outstanding plus days sales outstanding
- Days inventory outstanding minus days sales outstanding
Correct answer: Days inventory outstanding plus days sales outstanding minus days payable outstanding
CCC = DIO + DSO – DPO, measuring how long cash is tied up from inventory purchase to collection.
Question 5: A company wants to shorten its cash conversion cycle. Which action would be most effective?
- Paying suppliers earlier to gain discounts
- Increasing inventory safety stock levels
- Offering early payment discounts to customers (Correct answer)
- Extending the depreciation period for fixed assets
Correct answer: Offering early payment discounts to customers
Early payment discounts accelerate customer collections, reducing days sales outstanding and shortening the CCC.
Question 6: Under the direct method of reporting operating cash flows, which item would appear?
- Net income adjusted for depreciation
- Cash received from customers (Correct answer)
- Gain on sale of equipment
- Amortization of intangible assets
Correct answer: Cash received from customers
The direct method lists actual cash receipts from customers and cash payments to suppliers and employees.
Question 7: Free cash flow (FCF) is most commonly calculated as:
- Net income plus depreciation
- Operating cash flow minus capital expenditures (Correct answer)
- Gross profit minus operating expenses
- Net income minus dividends paid
Correct answer: Operating cash flow minus capital expenditures
FCF = Operating Cash Flow – Capital Expenditures, representing cash available after maintaining and expanding assets.
FAC Cash Flow Management 3
What is the primary purpose of a cash budget in cash flow management?