CIMA F1 Managing cash and working capital: practice questions with answers

Question 1

Which of the following features distinguishes invoice discounting from factoring?

1. A The finance provider advances cash to the business against the value of its trade receivables
2. B The finance provider charges interest on the cash advanced until customers pay
3. C The arrangement can be used to improve the business's cash flow when it is growing quickly
4. D The business keeps control of its own sales ledger and collects the debts itself, and customers are usually unaware of the arrangement

Show the answer

Answer: D. Both factoring and invoice discounting raise finance against receivables, with interest charged on advances. In factoring, the factor usually takes over sales ledger administration and debt collection (and may provide credit insurance under non-recourse terms); customers pay the factor. In invoice discounting, the business keeps control of its sales ledger and collects the debts itself, and the arrangement is usually confidential.

Question 2

Which short-term investment is a negotiable document issued by a bank, confirming that a sum has been deposited for a fixed term at a stated interest rate, so that the holder can sell it before maturity?

1. A A treasury bill
2. B Commercial paper
3. C A certificate of deposit
4. D A fixed-term deposit account

Show the answer

Answer: C. A certificate of deposit (CD) is issued by a bank to evidence a deposit for a fixed term at a stated rate. Because it is negotiable, the holder can sell it on the money market if cash is needed before maturity, combining a good return with liquidity. Treasury bills are issued by government; commercial paper by large companies; ordinary term deposits are not negotiable.

Question 3

Mapleton Co is introducing ABC analysis to control its inventory of 4,000 product lines. Which items should receive the closest control, such as frequent review, accurate demand forecasting and carefully calculated reorder levels?

1. A The items that make up the largest number of inventory lines
2. B The items with the lowest unit cost, because they are most easily lost or stolen
3. C The items that are held in the largest physical quantities
4. D The items that make up a small proportion of inventory lines but a large proportion of total annual usage value

Show the answer

Answer: D. ABC analysis applies the Pareto principle: items are ranked by annual usage value (annual usage x unit cost).

- A items: few lines (perhaps 10-20%) but most of the value (perhaps 70-80%); tight control.
- B items: moderate number and value; moderate control.
- C items: many lines but little value; simple controls such as periodic review or two-bin systems.

Question 4

Netherton Co is assessing the creditworthiness of a potential new customer. Which source of information is independent of the customer and usually provides a credit score based on payment records gathered from many businesses?

1. A A report from a credit reference agency
2. B Trade references from suppliers nominated by the customer
3. C Management accounts supplied by the customer
4. D A meeting with the customer's finance director

Show the answer

Answer: A. Sources for credit assessment include bank and trade references, published financial statements, the customer's own information, and credit reference agencies. Agencies are independent and pool information from many sources (payment records, court judgments, filed accounts) to give a credit score and suggested credit limit. Trade and bank references are nominated by, or given with the consent of, the customer and may be selective.

Question 5

A customer of Nevis Co has paid for goods with a 90-day bill of exchange that has been accepted by a major bank. Nevis Co needs cash immediately. Which of the following can Nevis Co do?

1. A Present the bill to the accepting bank for immediate payment of its full face value
2. B Sell the bill in the money market now for less than its face value
3. C Use the bill to reduce the VAT payable to the tax authority for the current quarter
4. D Convert the bill into equity shares in the customer at its face value

Show the answer

Answer: B. A bill of exchange is an unconditional order to pay a fixed sum on a fixed future date. When accepted by a bank (a banker's acceptance), it carries the bank's credit risk and is readily negotiable. The holder can wait until maturity for the face value, or discount (sell) the bill in the money market now for less than face value, the discount reflecting interest for the period to maturity.

Question 6

Ross Co holds fixed-rate bonds that pay a coupon of 5% a year and are redeemable at par in six years. If market interest rates on similar bonds rise from 5% to 7%, which of the following is most likely?

1. A The market price of the bonds rises, because investors expect higher returns
2. B The coupon on the bonds increases to 7% so that they remain competitive
3. C The market price of the bonds falls, so that their yield to maturity rises towards 7%
4. D The market price and the yield are unaffected, because the coupon is fixed

Show the answer

Answer: C. The price of a fixed-rate bond is the present value of its fixed coupons and redemption amount, discounted at the market rate. When market rates rise, the present value falls, so the price falls until the bond's yield to maturity matches the new market rate. This interest rate risk is a key consideration when investing surplus cash in bonds rather than in instruments held to maturity.