11. Working Capital, Treasury and Financial Risk Management

Introduction and Context

Working capital and treasury management concern the short-term financial decisions that keep an organization solvent, operational, and resilient. A profitable enterprise can still fail if it cannot pay suppliers, employees, lenders, or tax authorities when obligations fall due. Conversely, excessive liquidity may indicate inefficient use of capital, weak inventory discipline, or overly generous credit policies. The central managerial challenge is therefore not simply to maximize cash, but to maintain an appropriate balance between liquidity, profitability, risk, and operational continuity.

Working capital represents the funds committed to the operating cycle. It includes cash, trade receivables, inventories, and other current assets, less operating current liabilities such as trade payables and accrued expenses. Treasury management extends this perspective by coordinating cash flows, banking relationships, short-term investments, borrowing, foreign exchange, interest-rate exposure, and financial controls. Financial risk management provides the framework for identifying and controlling uncertainties that can affect cash flows, earnings, enterprise value, or access to finance.

For a technology-intensive organization, these issues are especially important. Software firms may have substantial receivables from institutional customers, hardware businesses may carry costly components and finished goods, and multinational enterprises may face currency exposures in contracts, payroll, and supplier payments. Effective management requires accounting information, operational data, financial modelling, technology platforms, and disciplined managerial judgement.

Learning Objectives

After studying this chapter, students should be able to:

1. Explain the nature and strategic significance of working capital and treasury management.

2. Analyse the operating cycle, cash conversion cycle, and major working-capital ratios.

3. Develop a short-term cash forecast using receipts, payments, and scenario assumptions.

4. Evaluate policies for managing receivables, inventory, payables, and short-term financing.

5. Distinguish liquidity risk, interest-rate risk, foreign-exchange risk, credit risk, and commodity-price risk.

6. Select and assess suitable hedging instruments and risk responses.

7. Design governance, control, technology, and reporting practices for a treasury function.

8. Apply these concepts to an integrated organizational case.

The Operating Cycle and the Logic of Working Capital

The operating cycle begins when an organization acquires materials or services and ends when it collects cash from customers. A manufacturing enterprise typically holds inventory, sells goods on credit, records receivables, and eventually receives cash. The operating cycle can be expressed as:

Operating Cycle = Inventory Conversion Period + Receivables Collection Period

Because purchases may be financed temporarily by supplier credit, the cash conversion cycle is usually more informative:

Cash Conversion Cycle = Inventory Conversion Period + Receivables Collection Period − Payables Deferral Period

The inventory conversion period measures the average number of days inventory remains before sale. The receivables collection period measures the average time between credit sale and cash collection. The payables deferral period measures the average period for which the organization uses supplier financing.

A shorter cash conversion cycle generally reduces the amount of external finance required, but an extremely short cycle is not automatically optimal. Aggressive reductions in inventory may cause stock-outs; strict credit policies may reduce sales; and excessive extension of supplier payment may damage relationships or create lost discounts. Working-capital policy must therefore be evaluated against service quality, bargaining power, industry practice, and risk tolerance.

Gross and Net Working Capital

Gross working capital refers to total current assets. Net working capital is current assets minus current liabilities. For operational analysis, analysts often distinguish operating working capital from financing items:

Operating Working Capital = Trade Receivables + Inventory − Trade Payables

Cash is often analysed separately because it is both a current asset and the principal treasury resource. A positive net working-capital balance may support liquidity, but it does not guarantee it. Current assets may be slow-moving, obsolete, disputed, or difficult to convert into cash. A detailed assessment must therefore examine quality, timing, and concentration rather than relying only on a balance-sheet total.

Permanent and Temporary Working Capital

Some working capital is permanently required because the business maintains a normal level of inventory and receivables even during quiet periods. Additional or temporary working capital arises from seasonal demand, expansion, project execution, or unusual supply conditions. A financing strategy may match long-term sources with permanent requirements and short-term sources with temporary needs. Maturity matching reduces refinancing risk, although it may increase financing cost compared with a more aggressive short-term strategy.

Managing the Main Working-Capital Components

Cash and Liquidity Buffers

Cash performs transaction, precautionary, and strategic functions. Transaction balances meet predictable payments; precautionary balances protect against uncertain receipts or emergencies; strategic liquidity may enable acquisitions, capacity expansion, or rapid response to market opportunities. Holding cash has an opportunity cost, while holding too little creates overdraft costs, payment failures, and reputational damage.

A sound liquidity policy defines minimum cash levels, approved investment instruments, counterparty limits, escalation procedures, and access to committed credit facilities. Short-term surplus cash should be invested according to safety, liquidity, and return priorities, in that order. Investments should not be selected merely for yield if they could lose value or become illiquid when funds are needed.

Receivables Management

Credit sales can increase revenue, but they transfer financing and default risk to the seller. Receivables management begins with customer credit assessment. Relevant information includes payment history, financial strength, industry conditions, credit ratings where available, ownership structure, order concentration, and contractual protections.

A credit policy normally specifies:

• customer approval authority and credit limits;
• payment terms and early-payment discounts;
• documentation, invoicing, and dispute procedures;
• monitoring frequency and overdue escalation;
• collection responsibilities and write-off approval.

The marginal benefit of liberal credit should be compared with the marginal cost of financing receivables, expected bad debts, administration, and collection. Useful measures include days sales outstanding, ageing schedules, overdue percentages, collection effectiveness, and concentration by customer or geography. A rising revenue figure accompanied by rapidly rising receivables may signal weak credit control rather than healthy growth.

Receivables can be financed through bank lines, factoring, invoice discounting, securitization, or supply-chain finance. These methods differ in cost, recourse, customer perception, legal structure, and risk transfer. Factoring without recourse may transfer specified credit risk to the factor, but the seller must understand exclusions, dilution risk, and concentration requirements.

Inventory Management

Inventory supports production and customer service, but it absorbs cash and may become obsolete. The main categories are raw materials, work in progress, finished goods, spare parts, and consumables. The appropriate policy depends on demand variability, replenishment lead time, supplier reliability, product life cycle, and the cost of stock-outs.

The economic order quantity model balances ordering and holding costs under simplifying assumptions:

EOQ = √(2DS/H)

where D is annual demand, S is ordering cost per order, and H is annual holding cost per unit. The model is a useful starting point but should not be treated as a mechanical answer when prices, lead times, capacity, or demand are uncertain.

Reorder-point systems trigger replenishment when inventory falls to expected demand during lead time plus safety stock. Safety stock protects against demand and supply variability, but its financial cost should be compared with the operational cost of stock-outs. ABC analysis classifies items according to value or criticality, allowing high-value or strategically important items to receive closer control. Modern organizations may supplement this with demand forecasting, barcode or radio-frequency identification, enterprise resource planning, and supplier collaboration.

Payables and Supplier Finance

Trade payables are a spontaneous source of finance, but payment practices must remain consistent with contracts, law, ethics, and supplier viability. Delaying payment beyond agreed terms can create hidden costs: lost discounts, supply interruption, poorer credit reputation, and higher prices in future negotiations.

Payment terms should be assessed using the effective cost of foregoing a discount. For example, if a supplier offers a 2% discount for payment in 10 days instead of the full amount in 40 days, the organization should compare the annualized benefit of the discount with its available financing cost. Payment centralization, electronic invoicing, three-way matching, and exception-based approval can improve control without unnecessarily delaying legitimate invoices.

Supply-chain finance may allow a financially strong buyer to facilitate early payment to suppliers through a bank or platform. This can support suppliers while preserving the buyer's agreed maturity, but the arrangement must be transparently documented and its accounting, liquidity, and reputational implications understood.

Measuring Working-Capital Performance

Ratios are useful when interpreted over time and against relevant benchmarks. Important measures include:

• Current ratio = Current assets / Current liabilities. It indicates broad short-term coverage but ignores timing and asset quality.
• Quick ratio = (Cash + short-term investments + receivables) / Current liabilities. It excludes inventory, which may be less liquid.
• Inventory days = Average inventory / Cost of sales × 365.
• Receivable days = Average trade receivables / Credit sales × 365.
• Payable days = Average trade payables / Credit purchases × 365.
• Cash conversion cycle = Inventory days + Receivable days − Payable days.

The interpretation of these measures requires caution. A low current ratio may be normal in a fast-cash retail business but dangerous in a project-based engineering firm. A high payable-days figure may reflect bargaining power or may indicate financial distress. Seasonal businesses should use monthly or daily data rather than relying only on year-end balances.

Cash Forecasting and Treasury Operations

Cash forecasting converts operational expectations into a time-based view of liquidity. A forecast normally contains opening cash, expected receipts, expected payments, financing flows, minimum required cash, and closing cash. The basic relationship is:

Closing Cash = Opening Cash + Cash Receipts − Cash Payments + Financing Inflows − Financing Outflows

A rolling forecast may cover 13 weeks, with the nearest weeks prepared in greater detail and later weeks based on broader assumptions. Forecasts should distinguish committed flows from uncertain flows. Customer receipts can be modelled using sales forecasts, payment patterns, ageing data, and collection assumptions. Supplier payments should incorporate purchase schedules, contractual terms, payroll, taxes, capital expenditure, debt service, and exceptional items.

Scenario analysis improves usefulness. A base case may reflect expected operations; a downside case may assume delayed collections, weaker sales, higher costs, or exchange-rate changes; and an upside case may reflect stronger demand. Sensitivity analysis identifies which assumptions have the greatest effect on liquidity. Forecast accuracy should be measured by comparing actual and forecast cash flows, classifying variances, and improving assumptions rather than simply blaming operating managers.

A treasury function commonly performs cash positioning, bank-account administration, payment execution, short-term investment, borrowing, foreign-exchange dealing, risk monitoring, and reporting. Segregation of duties is essential: the person initiating a transaction should not independently approve, settle, and reconcile it.

Short-Term Financing Choices

Organizations may finance temporary working-capital needs through overdrafts, revolving credit facilities, commercial paper, short-term loans, factoring, supplier finance, or internal cash pools. The choice depends on cost, flexibility, collateral, covenant requirements, maturity, market access, and refinancing risk.

An overdraft is flexible but may be repayable on demand. Commercial paper can be inexpensive for a highly rated issuer but may become unavailable during market stress. A committed revolving facility provides insurance but usually involves commitment fees and conditions. Factoring can accelerate cash collection but may be costly or affect customer relationships.

The risk of maturity mismatch is important. Financing long-lived or permanently required assets with very short-term borrowing exposes the organization to refinancing and interest-rate risk. Conversely, financing every temporary requirement with long-term debt may reduce flexibility and increase cost. A balanced policy combines maturity matching with a liquidity buffer and diversified funding sources.

Financial Risk: Identification and Measurement

Financial risk management begins with exposure identification. An exposure is an underlying position whose value or cash flow may change because of market conditions, counterparty performance, or funding availability. The objective is not to eliminate every risk; doing so may be impossible or uneconomic. The objective is to understand risk, determine acceptable limits, choose suitable responses, and monitor residual exposure.

Liquidity and Funding Risk

Liquidity risk is the possibility that an organization cannot meet obligations when due, even if its assets exceed liabilities in accounting terms. Funding risk includes the possibility that finance cannot be renewed or is available only at prohibitive cost. Indicators include forecast cash deficits, covenant headroom, undrawn facilities, maturity concentrations, customer collection delays, and dependence on a single lender.

Responses include maintaining cash buffers, committed facilities, diversified funding, contingency plans, tested payment procedures, and early-warning indicators. A liquidity stress test might assume a major customer pays late, sales fall, inventory cannot be liquidated at book value, and credit lines are partially unavailable.

Interest-Rate Risk

Interest-rate risk arises when changes in rates affect borrowing cost, investment income, asset values, or project viability. A borrower with floating-rate debt benefits when rates fall but suffers when they rise. A lender or cash investor has the opposite exposure. Duration, repricing gaps, interest coverage, and scenario analysis help measure sensitivity.

Common responses include fixed-rate borrowing, interest-rate swaps, caps, collars, and matching the duration of assets and liabilities. A swap may convert floating-rate payments into fixed payments, but it introduces valuation, documentation, basis, and counterparty considerations. Hedging should be connected to an underlying exposure and approved under a clear policy.

Foreign-Exchange Risk

Transaction exposure arises from contractual foreign-currency receipts or payments. Translation exposure arises when foreign subsidiaries' accounts are converted into the reporting currency. Economic exposure concerns the longer-term effect of exchange rates on competitiveness, pricing, and cash flows.

A firm expecting to receive euros in three months while its costs are in domestic currency faces a fall in domestic-currency value if the euro depreciates. It may use a forward contract to lock an exchange rate, an option to preserve upside while limiting downside, or a natural hedge by matching foreign-currency revenues with expenses or debt. Forecasts must distinguish firm commitments from uncertain forecasts because over-hedging can create speculative positions.

Credit and Counterparty Risk

Credit risk is the possibility that a customer, bank, supplier, derivative counterparty, or borrower fails to perform. Assessment includes financial information, payment history, external ratings, collateral, legal enforceability, concentration, and settlement arrangements. Exposure limits should be assigned by counterparty and aggregated across products and subsidiaries.

Credit derivatives or collateral arrangements may reduce some exposures, but they do not replace basic due diligence. Treasury should also monitor bank deposits, money-market investments, and derivative counterparties rather than treating banks as risk-free.

Commodity-Price Risk

Organizations exposed to fuel, metals, energy, agricultural inputs, or electronic components may experience substantial cash-flow volatility. Risk responses include fixed-price contracts, futures, forwards, swaps, options, supplier agreements, inventory policies, and passing changes through to customers. A hedge should be evaluated after considering basis risk, volume uncertainty, storage costs, margin requirements, and the relationship between the hedged item and the chosen instrument.

Hedging, Governance, and Control

A hedge reduces a specified exposure; it does not guarantee a profit. The first step is to define the risk objective: stabilizing cash flow, protecting a budget rate, preserving a margin, or reducing earnings volatility. The organization should then identify the exposure, measure its size and timing, select an instrument, obtain authorization, execute the transaction, and monitor effectiveness.

A treasury policy should establish permitted instruments, prohibited activities, dealing authorities, counterparty limits, hedge ratios, documentation, valuation methods, reporting frequency, and escalation rules. Speculative transactions unrelated to operating exposures should be prohibited unless the organization has exceptional expertise, governance, and mandate.

Key controls include independent confirmation, dual authorization, bank-account reconciliation, access controls, standardized legal agreements, independent valuation, exception reporting, limit monitoring, and periodic internal audit. The front office may execute transactions, the middle office may measure risk and compliance, and the back office may confirm, settle, account for, and reconcile them. Smaller organizations may combine roles, but compensating controls are necessary.

Accounting treatment for derivatives and hedges can affect reported earnings and equity. The precise requirements depend on the applicable reporting framework, documentation, eligibility, and effectiveness assessment. Financial managers must therefore coordinate treasury decisions with accounting, tax, legal, and audit professionals.

Technology, Analytics, and Emerging Practice

Treasury management systems integrate bank statements, enterprise resource planning data, payment workflows, forecasts, debt schedules, and market information. Application programming interfaces and host-to-host banking connections can improve transaction visibility. Robotic process automation may assist with reconciliations, confirmations, and exception handling.

Analytics can identify unusual payment patterns, predict collection delays, classify customers by risk, and improve demand and cash forecasting. Machine-learning models may detect anomalies, but their output depends on data quality and should remain subject to human review. Model risk arises when historical relationships change, data contain bias, or users mistake statistical prediction for certainty.

Contemporary treasury practice increasingly emphasizes real-time cash visibility, instant-payment risks, cyber resilience, environmental and supply-chain shocks, and integrated risk management. Cybersecurity is a financial control issue: payment redirection fraud, credential theft, and ransomware can produce immediate liquidity losses. Strong authentication, payment confirmation, segregation of duties, vendor-master controls, and staff awareness are therefore essential.

Illustrative Case: Meridian Devices Limited

Background

Meridian Devices Limited is a fictional mid-sized manufacturer of network equipment. It sells to distributors in several countries, imports specialized components in U.S. dollars, and finances part of its working capital through a floating-rate bank facility. Demand has grown, but the company has experienced longer customer payment times and excess inventory of older product models.

Situation and Problem

At the beginning of a quarter, Meridian has domestic-currency cash of 18 million. Its 13-week forecast shows receipts of 92 million and payments of 101 million before financing. Payments include payroll, suppliers, taxes, interest, and a planned equipment purchase. The company requires a minimum operating balance of 12 million. Two large distributors, representing 34% of receivables, have recently moved from 45-day to nearly 75-day payment patterns. In addition, the company must pay U.S. dollar suppliers in six weeks, while its bank facility reprices monthly.

The finance director must determine whether the problem is temporary, identify the principal risks, and propose an integrated response without damaging supplier relationships or customer service.

Analysis

The forecast indicates a pre-financing closing balance of 9 million, which is 3 million below the minimum. The immediate issue is liquidity, but the underlying causes are a lengthening receivables period and inventory accumulation. If the receivables collection period has increased from 45 to 75 days, the cash conversion cycle has lengthened even if sales remain strong. Inventory reduction may release cash, but indiscriminate discounting could destroy margins.

The company also has transaction foreign-exchange exposure on the dollar purchase and interest-rate exposure on its floating-rate facility. Distributor concentration creates credit risk. The planned equipment purchase is discretionary in timing and can be reconsidered, while supplier payments may require negotiation rather than unilateral delay.

Strategy and Solution

Meridian should first update the rolling forecast weekly for the next 13 weeks and separate committed from uncertain receipts. It should contact the two distributors, validate disputed invoices, establish payment plans, and apply credit limits to new orders. A targeted early-payment incentive can be offered only where its financing benefit exceeds the discount cost.

The company should classify inventory by demand and obsolescence risk, stop replenishment of slow-moving models, and negotiate returns or exchanges with suppliers where commercially feasible. The equipment purchase should be deferred until the forecast shows adequate headroom. Supplier discussions should seek revised schedules or supply-chain finance rather than concealed overdue balances.

For funding, Meridian can draw a portion of its committed revolving facility while preserving a minimum liquidity buffer. It should compare the cost of borrowing with receivables financing and avoid relying entirely on an uncommitted overdraft. The expected dollar payment can be hedged with a forward contract if the amount and date are sufficiently certain. For uncertain future dollar purchases, partial hedging or options may be more appropriate. Interest-rate sensitivity should be quantified, and an interest-rate cap or fixed-rate portion may be considered within policy limits.

The treasury manager should aggregate distributor, bank, and derivative exposures; establish daily cash visibility; and require independent confirmation and reconciliation of all hedges. Senior management should receive a dashboard covering cash headroom, forecast accuracy, overdue receivables, inventory ageing, covenant headroom, currency positions, and counterparty limits.

Outcome

In this illustrative case, the combined measures restore the forecast balance above the minimum without a broad reduction in sales. The most important improvement does not come from one derivative or one borrowing decision. It results from connecting collections, inventory, procurement, capital expenditure, funding, and risk controls in one forecast-driven process.

Learning Points

The case demonstrates that working-capital problems often appear first as liquidity symptoms but require operational remedies. Hedging protects identifiable exposures; it does not cure weak collections or obsolete inventory. A credible forecast, clear priorities, and integrated governance are more valuable than isolated short-term actions.

Common Mistakes and Professional Considerations

Common mistakes include treating profit as cash, using year-end ratios to represent seasonal conditions, extending supplier payments without considering ethical and contractual consequences, assuming all current assets are liquid, hedging forecast volumes that never occur, and permitting one employee to initiate and settle treasury transactions. Other errors include ignoring concentration risk, failing to stress-test covenants, selecting derivatives for apparent sophistication, and overlooking tax, accounting, legal, or documentation effects.

Professional conduct requires transparent reporting of liquidity constraints, fair treatment of suppliers and customers, protection of confidential financial data, and avoidance of conflicts of interest. Treasury decisions should not be used to conceal operational underperformance. Governance bodies must receive a truthful picture of forecast uncertainty, not merely a point estimate that supports a preferred decision.

Best-Practice Framework

A mature working-capital and treasury system generally includes:

1. A documented liquidity and treasury policy approved by the governing authority.

2. A rolling cash forecast connected to sales, procurement, payroll, tax, capital expenditure, and financing data.

3. Clear ownership of receivables, inventory, payables, and risk exposures.

4. Defined limits for cash, investments, counterparties, currencies, debt, and derivatives.

5. Segregation between dealing, risk oversight, settlement, accounting, and reconciliation.

6. Scenario and stress testing, including severe but plausible liquidity events.

7. Regular measurement of forecast accuracy and cash-conversion performance.

8. Secure, integrated technology with strong access and cyber controls.

9. Periodic independent review by internal audit, risk, external audit, or the board.

10. Continuous coordination among finance, operations, procurement, sales, legal, tax, and information security.

Chapter Summary

Working capital management seeks to balance liquidity, profitability, operational reliability, and risk. The operating cycle explains how cash is committed to inventory and receivables and recovered through customer collections; the cash conversion cycle additionally recognizes supplier financing. Effective management requires disciplined policies for cash, receivables, inventory, and payables, supported by meaningful ratios and time-based cash forecasts.

Treasury management coordinates liquidity, banking, funding, investments, foreign exchange, interest rates, and financial controls. Financial risk management identifies exposures, measures their possible effects, establishes limits, and selects responses such as natural hedges, forwards, options, swaps, diversification, and contingency funding. Hedging must be linked to genuine exposures and governed through authorization, documentation, independent valuation, settlement, and reconciliation.

The chapter also shows that technology can improve visibility, forecasting, automation, and anomaly detection, but data quality, model risk, and cybersecurity remain important. Strong practice integrates financial and operational decisions: collections, inventory, procurement, capital expenditure, funding, and risk cannot be managed effectively as isolated activities.

Key Terms

Working capital: Funds committed to current assets and supported by current liabilities in day-to-day operations.

Operating working capital: Trade receivables plus inventory less trade payables.

Operating cycle: Time from acquiring inputs to collecting cash from customers.

Cash conversion cycle: Inventory period plus receivables period less payables period.

Liquidity: Ability to meet financial obligations when they fall due.

Cash forecast: Time-based estimate of future cash receipts, payments, financing, and balances.

Receivables management: Policies and procedures governing customer credit, billing, collection, and default risk.

Inventory conversion period: Average number of days inventory is held before sale or use.

Receivables collection period: Average number of days required to collect customer balances.

Payables deferral period: Average time taken to pay suppliers.

Safety stock: Additional inventory held to protect against demand or supply uncertainty.

Treasury management: Coordination of cash, funding, investments, banking, and financial exposures.

Liquidity risk: Risk of being unable to meet obligations on time.

Interest-rate risk: Risk that rate movements affect borrowing cost, investment income, or value.

Foreign-exchange risk: Risk that currency movements change the domestic value of transactions or positions.

Credit risk: Risk that a counterparty fails to meet contractual obligations.

Commodity-price risk: Risk arising from adverse changes in prices of inputs or outputs.

Hedge: A transaction or operational arrangement designed to reduce a specified exposure.

Natural hedge: Reduction of risk by matching revenues, costs, assets, or liabilities in the same currency or price basis.

Counterparty limit: Maximum permitted exposure to a particular customer, bank, supplier, or financial institution.

Review Questions

Short Answer Questions

1. Distinguish gross working capital from net working capital.

2. What is the difference between the operating cycle and the cash conversion cycle?

3. Why can a high current ratio fail to demonstrate strong liquidity?

4. State two purposes of a rolling cash forecast.

5. Define a natural hedge and provide one example.

Long Answer Questions

1. Explain how receivables, inventory, and payables policies influence the cash conversion cycle and profitability.

2. Discuss the structure, uses, and limitations of a 13-week cash forecast.

3. Analyse the principal short-term financing alternatives available to an organization.

4. Explain how a treasury policy and segregation of duties reduce financial and operational risk.

5. Compare forwards, options, swaps, and natural hedges as responses to financial exposures.

Analytical / Application Questions

1. A firm has inventory days of 58, receivables days of 46, and payable days of 35. Calculate its cash conversion cycle and explain two operational actions that could reduce it without impairing service quality.

2. A company expects to pay a fixed amount in foreign currency in three months, but the exact amount may vary by 30%. Recommend an appropriate hedging approach and discuss the risk of over-hedging.

3. A business reports rising profits but repeatedly draws on an overdraft. Using the concepts in this chapter, diagnose possible causes and design a management dashboard for the next quarter.

22. Multiple Choice Questions with Answers

Question 1

Which expression correctly represents the cash conversion cycle?

A. Receivables days + payable days − inventory days

B. Inventory days + receivables days − payable days

C. Current assets − current liabilities

D. Inventory days − receivables days + payable days

Correct Answer: B. Inventory days + receivables days − payable days

Question 2

A firm reduces inventory days but experiences frequent production stoppages. What is the most appropriate interpretation?

A. The firm has necessarily optimized working capital

B. The reduction may have transferred inventory cost into stock-out and disruption costs

C. The current ratio must have increased

D. The firm has eliminated liquidity risk

Correct Answer: B. The reduction may have transferred inventory cost into stock-out and disruption costs

Question 3

Which item is most directly included in a 13-week cash forecast?

A. Only annual accounting profit

B. Opening cash, expected receipts, payments, financing flows, and closing cash

C. Only non-cash depreciation expense

D. Only the balance-sheet value of fixed assets

Correct Answer: B. Opening cash, expected receipts, payments, financing flows, and closing cash

Question 4

A company expects to receive foreign currency in three months and wants to lock the domestic-currency value. Which instrument most directly serves this objective?

A. A forward contract

B. An inventory reorder point

C. A trade discount

D. A current ratio calculation

Correct Answer: A. A forward contract

Question 5

Which situation best illustrates liquidity risk?

A. A customer disputes an invoice but pays on time

B. An organization has sufficient accounting assets but cannot make a payment when due

C. A company earns more revenue than expected

D. A supplier offers a cash discount

Correct Answer: B. An organization has sufficient accounting assets but cannot make a payment when due

Question 6

What is a principal danger of hedging uncertain forecast purchases with a firm derivative contract?

A. The organization may create an uncovered speculative position if the purchases do not occur

B. The organization automatically eliminates all credit risk

C. The organization must increase inventory days

D. The organization cannot prepare a cash forecast

Correct Answer: A. The organization may create an uncovered speculative position if the purchases do not occur

Question 7

Which control most directly prevents one employee from initiating, settling, and reconciling the same treasury transaction?

A. Segregation of duties

B. Increasing the current ratio

C. Reducing safety stock

D. Extending customer credit terms

Correct Answer: A. Segregation of duties

Question 8

A company has floating-rate debt and is concerned about rising interest rates. Which response is most directly relevant?

A. An interest-rate cap or conversion to fixed-rate borrowing

B. Reducing receivable ageing data

C. Increasing supplier payment delays without agreement

D. Increasing obsolete inventory

Correct Answer: A. An interest-rate cap or conversion to fixed-rate borrowing

Question 9

Which measure is most useful for identifying customer payment deterioration?

A. Receivables ageing and collection days

B. Fixed-asset turnover alone

C. Dividend payout alone

D. Gross margin without cash-flow data

Correct Answer: A. Receivables ageing and collection days

Question 10

In the Meridian Devices case, which combination addresses both the immediate cash deficit and its operational causes?

A. Borrowing only, without reviewing collections or inventory

B. Deferring all supplier payments indefinitely

C. Improving collections, reducing obsolete inventory, reviewing discretionary expenditure, and arranging controlled funding

D. Entering speculative currency trades

Correct Answer: C. Improving collections, reducing obsolete inventory, reviewing discretionary expenditure, and arranging controlled funding