Question

Which of the following statements is CORRECT?

a. Depreciation is included in the estimate of cash flows (Cash flow = Net income = Depreciation); hence depreciation is set forth on a separate line in the cash budget.

b. If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10 net 30 to net 60.

c. Sound working capital policy is designed to maximize the time between cash expenditures on materials and the collection of cash on sales.

d. If cash inflows from collections occur in equal daily amounts but most payments must be made on the 10th of each month, then a regular monthly cash budget will be misleading. The problem can be corrected by using a daily cash budget.

e. If a firm sells on terms of net 90, and if its sales are highly seasonal, with 80% of its sales in September, then its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower in October than in August.

Answer 1

Answer:

Correct answer is:

d. If cash inflows from collections occur in equal daily amounts but most payments must be made on the 10th of each month, then a regular monthly cash budget will be misleading. The problem can be corrected by using a daily cash budget.

Explanation:

As Cash inflows occurs in equal daily amounts but payments are made on 10th, monthly cash budget will be misleading. Monthly budget may show net cash surplus but on 10th when all payments for the month are made, there would possibly be deficit since collections for only 10 days are received. In such situation daily cash budget will be appropriate.

As such option D is correct.

Option A is incorrect since cash budget includes cash receipts and cash payments and as such depreciation is not shown a separate line in the cash budget.

Option B is incorrect since if a firm wants to generate more cash flow from operations in the next month or two, it should reduce credit terms net 30 to say net 20 or net 10 or net days< 30

Option C is incorrect since sound working capital policy is designed to minimize (not maximize) the time between cash expenditures on materials and the collection of cash on sales.

Option E is incorrect since in the given situation DSO will be higher in October than in August.