F1: Cash and working capital

Answer: D. The working capital cycle is the time gap between cash outflows (paying for raw materials and labour) and cash inflows (collecting payment from customers). It encompasses: raw materials storage time → work-in-progress time → finished goods storage time → credit period allowed to customers → less credit period received from suppliers. A longer cycle means more cash is tied up in working capital. The cash conversion cycle (CCC) quantifies this: CCC = inventory days + receivables days − payables days.

Answer: A. Cash conversion cycle (CCC) = inventory days + receivables days − payables days = 60 + 40 − 35 = 65 days. The CCC measures the net time the company's cash is tied up in the operating cycle. A shorter CCC is preferable as it means less funding is required. The 95-day figure adds all three (ignoring the credit received from suppliers). The 100-day figure might add inventory and receivables only (60 + 40 = 100), omitting the payables benefit. The 25-day figure subtracts both receivables and payables from inventory.

Answer: B. Receivables days = (trade receivables ÷ credit sales) × 365 = (£60,000 ÷ £365,000) × 365 = 60 days. Using a 365-day year: £60,000/£365,000 × 365 = 60 days exactly (since the denominator and the multiplier of 365 simplify). 45, 50 and 73 days do not follow from the figures; because credit sales are £365,000, each £1,000 of receivables represents one day. Receivables days measure how long customers take to pay on average — a rising trend may indicate deteriorating credit control or customers taking extended credit.

Answer: C. Current ratio = current assets ÷ current liabilities = £150,000 ÷ £100,000 = 1.5. Quick ratio = (current assets − inventory) ÷ current liabilities = (£150,000 − £30,000) ÷ £100,000 = £120,000 ÷ £100,000 = 1.2. The quick ratio excludes inventory as the least liquid current asset. A current ratio above 1.0 means current assets exceed current liabilities; the quick ratio gives a more conservative liquidity measure. A ratio of 1.2 and 1.5 reverses the two measures.

Answer: D. The EOQ model seeks the order quantity that minimises the total of ordering costs (costs incurred each time an order is placed, such as administration and delivery charges) and holding costs (costs of physically storing inventory, including rent, insurance and deterioration). As order quantity increases, ordering costs fall (fewer orders placed) but holding costs rise (more inventory held on average). The EOQ is the point where total ordering costs equal total holding costs, minimising their combined total. Purchase price and lead time are relevant to other decisions but are not what the EOQ balances.

Answer: A. In factoring, the factor provides finance against invoices and also takes over the administration and collection of the receivables ledger — chasing customers for payment on the client's behalf. In invoice discounting, the client borrows against the value of its invoices but retains responsibility for managing and collecting its own sales ledger, so customers may be unaware of the arrangement (confidential invoice discounting). Both involve raising finance against receivables; the key distinction is who manages collection. Factoring is often more expensive due to the additional credit management service.

Answer: D. Payables days = (trade payables ÷ cost of sales) × 365 = (£80,000 ÷ £730,000) × 365 = 40 days. Some calculations use purchases rather than cost of sales as the denominator when available. Payables days measure how long on average the company takes to pay its suppliers. A longer period conserves cash but risks damaging supplier relationships. Combined with receivables days and inventory days, payables days form the cash conversion cycle: CCC = inventory days + receivables days − payables days. 60, 50 and 30 days do not follow from the figures; because cost of sales is £730,000, each £2,000 of payables represents one day.

Answer: A. Inventory days = (average inventory ÷ cost of sales) × 365 = (£50,000 ÷ £365,000) × 365 = 50 days. Inventory days measure how long on average goods are held in stock before being sold. A high figure indicates slow-moving or excess inventory, tying up cash; a very low figure could indicate risk of stockouts. The calculation uses cost of sales (not revenue) in the denominator because inventory is measured at cost. When calculating working capital cycle: cash conversion cycle = inventory days + receivables days − payables days. 60, 40 and 73 days do not follow from the figures; with cost of sales of £365,000, each £1,000 of inventory represents one day.

Answer: B. An aggressive working capital strategy keeps current assets low (lean inventory, short credit terms to customers, minimum cash buffers) and relies heavily on short-term financing (overdraft, trade credit) to fund operations. This minimises the cost of holding working capital but increases risk — the risk of stockouts, customer loss due to tight credit, and liquidity crises if short-term funding is withdrawn or rates rise. A conservative strategy holds higher current assets funded more with long-term finance, reducing risk but increasing cost. A matching (moderate) strategy aligns asset and funding maturities.

Answer: C. EOQ = √(2 × annual demand × ordering cost per order ÷ holding cost per unit) = √(2 × 10,000 × £50 ÷ £2) = √500,000 = 707 units (rounded). At this quantity, total ordering costs and total holding costs are equal and their combined total is minimised. 500 omits the 2 from the formula (√(10,000 × £50 ÷ £2)), 1,000 omits the division by the holding cost (√(2 × 10,000 × £50)), and 354 is half the correct answer. The EOQ model assumes constant demand, known costs and no quantity discounts.

Answer: B. Annualised cost of not taking the discount = (discount % ÷ (1 − discount %)) × (365 ÷ days saved) = (0.02 ÷ 0.98) × (365 ÷ 50) = 2.041% × 7.3 = 14.9%. This represents the implicit interest cost of continuing to use the full 60-day trade credit instead of paying early to capture the discount. Since this cost (14.9%) exceeds the cost of short-term borrowing (10%), it is cheaper to borrow at 10% and pay within 10 days than to forgo the discount and pay at the normal 60-day date — the company should take the discount. Always declining settlement discounts to preserve cash ignores that the cash can be sourced more cheaply through borrowing than the discount actually costs to forgo. Treating 2% as always worth taking regardless of borrowing costs happens to reach the right conclusion here but for the wrong reason — the flat 2% figure is not comparable to an annual borrowing rate until it is annualised, and in other scenarios (a smaller gap in days, or a higher borrowing rate) this shortcut would give the wrong answer. The reversed comparison (treating 14.9% as below 10%) simply misstates the two figures, which is why the direction of the conclusion is wrong.

Answer: A. A bank overdraft is flexible short-term borrowing: the company draws down and repays as needed (within an agreed facility limit), and interest is charged only on the amount actually outstanding. The key risk is that it is technically repayable on demand — the bank can withdraw the facility, though in practice this is unusual with well-managed accounts. Overdrafts are not fixed long-term funds and they are used specifically for working capital purposes, such as bridging temporary cash shortfalls. They are not necessarily secured against non-current assets.

Answer: A. Proactive credit control begins before a debt becomes problematic — by screening customers before extending credit (credit checks, references, credit agency reports) and setting appropriate credit limits based on assessed risk. This prevents bad debts rather than reacting to them. Writing off bad debts is reactive; legal action is a last resort that damages relationships; and offering uniform 120-day credit to all customers regardless of creditworthiness would create higher bad debt risk. A good credit management system combines pre-credit screening, ongoing monitoring, prompt follow-up of overdue accounts and escalation procedures.

Answer: B. An aged debtor analysis categorises outstanding receivables by age — for example, current (0-30 days), 30-60 days, 60-90 days and over 90 days. This allows credit controllers to identify which customers are significantly overdue and prioritise follow-up, and helps management assess the overall quality of the receivables book. It does not predict future payments, send reminders automatically or perform ledger reconciliation — those are separate functions. The aged analysis is a management reporting tool that drives credit control activity.

Answer: C. Cash released = reduction in trade receivables = £80,000 − £60,000 = £20,000. The new receivables days = £60,000/£365,000 × 365 = 60 days (a 20-day improvement). Reducing receivables days releases cash that was previously tied up in credit extended to customers. This cash can be used to repay short-term borrowings, fund investment, or reduce the overdraft. The £60,000 figure is the new receivables balance, not the cash released.

Answer: D. JIT aims to receive materials and produce goods exactly when needed, eliminating (or minimising to the practical minimum) inventory at every stage. Benefits include: zero or near-zero storage costs, no capital tied up in stock, reduced obsolescence risk, and a focus on quality (defects cannot be hidden in buffer stock). The main risk is supply chain disruption causing production stoppages — JIT requires highly reliable suppliers and precise demand forecasting. JIT does not use the EOQ model, which assumes batch ordering; JIT implies very small, frequent deliveries.

Answer: A. Commercial paper is an unsecured, short-term promissory note issued at a discount and redeemed at face value, typically used by large, creditworthy companies to raise short-term funds directly from investors in the money market. It bypasses banks, often at lower cost than an overdraft. Maturities are short (typically 7–270 days). Only companies with strong credit ratings can issue commercial paper, as there is no collateral. It is not a payment instrument, a government scheme, or a long-term bond.

Answer: B. Invoice discounting provides the business with a cash advance (typically 80–90% of invoice value) against its outstanding trade receivables, while the business continues to manage its own sales ledger and collect debts. Customers are usually unaware of the arrangement (confidential invoice discounting). Factoring, by contrast, transfers the receivables management function to the factor. Both provide working capital finance against receivables, but they differ in who manages collection. Neither guarantees payment (bad debt protection requires additional 'non-recourse' factoring).

Answer: C. The matching principle holds that the maturity of financing should correspond to the maturity of the assets being financed: non-current (fixed) assets should be funded by long-term sources (equity, long-term debt); permanent current assets (the irreducible minimum level of inventory and receivables) by medium-term finance; and fluctuating current assets by short-term, flexible sources like overdraft. Funding long-term assets with short-term finance creates rollover risk (the funding cannot be renewed). Funding short-term assets with long-term finance is costly and inefficient. This is the basis of the moderate working capital financing strategy.

Answer: C. EOQ = √(2 × 36,000 × £150 ÷ £3) = √(3,600,000) = 1,897 units (rounded). Number of orders per year = 36,000 ÷ 1,897 ≈ 19 orders. At this quantity, total ordering costs = 19 × £150 = £2,850 and total holding costs = (1,897/2) × £3 = £2,846 — essentially equal (small rounding difference), confirming the EOQ minimises their sum. The EOQ of 2,000 assumes rounding to a convenient number. The average inventory held at the EOQ = 1,897 ÷ 2 = 949 units. 1,500 and 3,600 units do not follow from the EOQ formula; ordering 3,600 units ten times a year would push holding costs well above ordering costs.

Answer: D. Holding excess cash provides liquidity but incurs an opportunity cost — the cash is earning minimal interest when it could be invested in higher-return assets, used to reduce debt (saving interest), or returned to shareholders. Good treasury management seeks to optimise cash balances: holding enough for operational needs and planned payments while deploying surplus cash in short-term instruments (money market funds, treasury bills) to earn a return. Holding excess cash does not maximise ROCE (it sits idle), is not universally optimal, and does not eliminate risk.

Answer: A. Seasonal businesses build inventory ahead of peak demand, and receivables increase as goods are sold on credit during the peak period — both of these increase working capital requirements before and during the peak season. After peak season, inventory is depleted and receivables are collected, releasing cash. The fluctuating current assets created by seasonal demand are typically funded by flexible short-term finance (overdraft, seasonal revolving credit) rather than long-term finance, which would be inefficient to maintain year-round. Understanding seasonal patterns is critical to cash flow planning.

Answer: B. Treasury manages the company's financial resources: ensuring adequate liquidity (cash management and forecasting), managing short-term investments of surplus funds, negotiating and managing borrowings, managing foreign exchange and interest rate exposures, and maintaining banking relationships. In larger companies, treasury also manages longer-term capital structure decisions. Financial statements, management accounts and pricing strategy are responsibilities of other finance and commercial functions. The treasury function operates at the interface between the business and the financial markets.

Answer: C. Unilaterally extending payment beyond agreed terms (stretching creditors) conserves short-term cash but damages supplier relationships. Suppliers may react by withdrawing credit terms entirely (requiring upfront payment), increasing prices to compensate for late payment, reducing the quality or priority of supply, or pursuing legal action. In extreme cases, key suppliers may stop supplying altogether, disrupting operations. The cash flow benefit is real but short-term; the reputational and operational risks can be severe. Settlement discounts become unavailable when paying late, and the current ratio may actually worsen if long-term obligations are reclassified.

Answer: D. Proactive treasury management uses cash budget forecasts to plan: surplus cash in months 1–3 should be invested (even in overnight or short-term money market instruments) to earn a return rather than sitting idle in a current account. The anticipated months 4–6 deficit should be arranged in advance through a pre-agreed credit facility (overdraft, revolving credit), avoiding the cost and urgency of arranging emergency finance. A long-term loan would be inefficient for a short-term funding gap; accelerating expenditure would worsen the deficit months rather than help.

Answer: A. Non-recourse factoring transfers the credit risk to the factor: if the customer fails to pay, the factor bears the loss and cannot claim the amount back from the client. In recourse factoring, if the customer does not pay the factor retains the right to reclaim the advance from the client (the credit risk stays with the client). Non-recourse factoring is more expensive because the factor is accepting additional risk. From the client's perspective, non-recourse arrangements effectively provide both working capital financing and bad debt insurance. Governments and loss-sharing arrangements are not part of the standard factoring structure.

Answer: B. A conservative working capital policy holds higher current asset levels (more inventory, longer credit to customers, larger cash buffers) and funds them with a greater proportion of long-term finance. This reduces the risk of stockouts, customer dissatisfaction and liquidity crises, but costs more because long-term finance is generally more expensive than short-term and idle current assets earn poor returns. An aggressive policy does the opposite — minimise current assets and rely on short-term, cheaper funding — accepting higher risk for lower cost. Most businesses adopt a moderate approach between these extremes.

Answer: C. The settlement discount costs the company 2% of the invoice value for each customer who takes it. However, the company benefits from receiving cash earlier — this earlier receipt can be used to reduce overdraft borrowing (saving interest), or invested (earning a return). The net cost is the discount given less the financial benefit of early receipt. Whether offering the discount makes economic sense depends on comparing the annualised cost of the discount (similar to the calculation from the customer's perspective) with the company's cost of capital or overdraft rate. If early receipt saves more than the discount costs, it is worthwhile.

Answer: D. Over-trading (also called under-capitalisation) occurs when a business expands rapidly but does not have sufficient working capital to fund the growth — it becomes profitable on paper but runs out of cash. Expanding businesses need more inventory, make more sales on credit (increasing receivables), and face increased operational costs before cash is collected. If growth is not properly financed, the business can fail despite being profitable. Poor working capital management can also lead to the reverse — excessive working capital tied up in slow-moving inventory or overdue receivables, reducing returns and potentially triggering a liquidity crisis.

Answer: A. The quick (acid test) ratio = (current assets − inventory) ÷ current liabilities. A fall from 1.4 to 0.9 means the liquid current assets no longer fully cover current liabilities (below 1.0). This signals deteriorating short-term liquidity — possibly because receivables are growing (slower collection), cash has been used up, short-term borrowings have increased, or a combination. It has no direct relationship with profitability or long-term debt repayment. Improving inventory management would reduce inventory (which is excluded from the quick ratio anyway) and might improve cash but is not the direct cause of a falling quick ratio.

Answer: B. Trade credit delays cash payment to suppliers and is effectively cost-free if the supplier is not offering a settlement discount — the company simply takes the full agreed credit period. However, if a settlement discount is available and not taken, the implied cost of the free credit is the foregone discount (which can be significant when annualised). Trade credit is widely available to businesses of all sizes, typically without the credit rating requirements of bank facilities. The decision to pay promptly (taking discounts) versus taking full credit involves comparing the discount's annualised cost with the company's cost of finance.

Answer: B. Over-trading shows up in working capital ratios as the business stretches its financing to fund growth: the current ratio declines (current liabilities growing faster than current assets as creditors are relied upon more heavily); payables days rise (stretching suppliers to fund the growth); and receivables days may fall or inventory turns may be very high as the business races to convert assets to cash. The combination of a worsening current ratio with extended creditors and high asset turnover is the classic over-trading pattern. A rising current ratio with low payables days would suggest the opposite.

Answer: C. Cash flow forecasts track when cash actually changes hands — when invoices are collected, when suppliers are paid, when tax is paid — reflecting the timing of real cash movements rather than the accruals-based matching of income and expense. A business can be profitable but have a cash deficit if it is collecting cash slowly while growing quickly (over-trading), or has capital expenditure not yet fully depreciated. Cash flow forecasting is essential for liquidity planning and is used for internal management, lender covenant monitoring and investment appraisal — it is not a legal requirement but is critically important in practice.

Answer: D. Cash advance = 85% × £500,000 = £425,000. Factoring fee = 1.5% × £500,000 = £7,500 (charged on gross invoice value). The £6,375 figure arises from applying 1.5% to the advance amount (£425,000 × 1.5%) rather than to the face value of the invoices. Fees are conventionally quoted as a percentage of gross invoice value. Net cash received = £425,000 − £7,500 = £417,500. Under non-recourse factoring, the factor absorbs bad debts and cannot reclaim the advance from the client.

Answer: A. The quick ratio excludes inventory from current assets, on the basis that inventory may take time to sell and convert to cash — it is the least liquid of the current assets. The current ratio includes inventory and may therefore overstate true short-term liquidity, particularly for businesses with slow-moving or specialised stock. The quick ratio is more conservative and focused on assets that can be converted to cash quickly (receivables and cash). It always produces a lower figure than the current ratio (because some assets are excluded). The calculation is straightforward: (current assets − inventory) ÷ current liabilities.

Answer: B. A revolving credit facility (RCF) provides a pre-agreed credit limit that the borrower can draw down, repay and redraw as needed — similar in flexibility to an overdraft but typically with a committed availability period (e.g., 3 or 5 years). This makes it well-suited to fluctuating working capital needs. A term loan is drawn in full at the start and repaid in scheduled instalments, suited to financing a specific asset or project. RCFs may be secured or unsecured depending on the borrower's creditworthiness and are available to companies of all sizes, not just banks.

Answer: C. The reorder level is the stock level at which a new order must be triggered so that the delivery arrives before stock runs out. Basic calculation: reorder level = average daily demand × average lead time (the time between placing and receiving an order). If safety (buffer) stock is held to cover demand variability, this is added: reorder level = (average daily demand × average lead time) + safety stock. Maximum demand × maximum lead time gives the maximum reorder level — the highest level at which stock could drop to zero if delivery is late and demand is high. EOQ/2 is the average inventory level, not the reorder point.

Answer: D. Net working capital = current assets − current liabilities. Current assets = trade receivables (£90,000) + inventory (£60,000) + cash (£10,000) = £160,000. Current liabilities = trade payables (£70,000) + accruals (£20,000) = £90,000. Net working capital = £160,000 − £90,000 = £70,000. Positive net working capital means current assets exceed current liabilities, providing a buffer for short-term obligations. The £160,000 figure is total current assets, not net working capital. Net working capital is a key measure of short-term financial health. £150,000 is receivables plus inventory only, leaving out cash and all the liabilities.