IGCSE Enterprise: Specimen Questions with Answers 33 - 34 of 49

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Case Study: 3

Fazzari and Petersen (1993) argue that investment in working capital is sensitive to cash flow. Their findings show that firms that have larger capacity to generate internal finance have higher current asset levels. Chiou et al. (2006) also provide evidence from Taiwan to point to the influence of cash flow on investment in working capital and suggest that firms with greater cash flow have higher investment in working capital. Hill et al. (2010) show that firms with available internal cash flow capacity and capital market access invest more in working capital. By contrasting the two spectrums of researches, it can be suggested that the level of investment in working capital depends on the cash flow availability of firms (Fazzari et al. , 1988) . As argued by Banos-Caballero et al. (2014) , a positive working capital level needs financing, and therefore cash flow availability plays an important role in the relationship between WCM and firm performance.

These positive and negative influences of NWC on performance suggest that investment in working capital involve a trade-off (Baños-Caballero et al. , 2012; Deloof, 2003) . Therefore, to test the effect of cash flow on the relationship between NWC and performance, I estimate a non-linear regression similar to that of Banos-Caballero et al. (2012) and Banos-Caballero et al. (2014) . In this regard, it can be argued that whilst firms with limited cash flow should strive to achieve a reduction in working capital investment to avoid the need for expensive external finance; on the contrary, firms with available internal cash flow should increase investment in working capital in order to improve performance. Banos-Caballero et al. (2014) conclude in their research that managers should avoid negative effects on firm performance because of additional financing expenses. Internal cash flow can be used to finance investments in working capital without the need to raise costly external finance (Autukaite and Molay, 2011) . Banos-Caballero et al. (2014) examined the functional form of the relation between investment in working capital and corporate performance by taken into account financial constraint and found a convex relationship between investment in working capital and firm performance.

Question 33 (8 of 12 Based on Passage)

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Short Answer▾

Explain the importance of financial management for a business.

Explanation

Financial management is that managerial activity which is concerned with the planning and controlling of the firm՚s financial resources. Management of funds is a critical aspect of financial management. Management of funds act as the foremost concern in any kind of business.

  • Financial planning and successful promotion of enterprise
  • Acquisition of finds and when required at minimum possible cost
  • Proper use and allocation of funds
  • Improving the profitability through financial controls
  • Increasing the wealth of investors and the nation.
  • Promoting and mobilizing individual and corporate savings.

Question 34 (9 of 12 Based on Passage)

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Short Answer▾

Cash flow availability plays an important role in the relationship between WCM and firm performance. Use this statement to answer the question below-

Give two advantages and disadvantage of trade credit.

Explanation

Trade credit refers to the credit extended by the suppliers of goods in normal course of business. It gives the business 1 - 3 months to pay after purchasing it supplies.

Advantages

  • Useful as the company can sell its finished product and sell it before having to pay the suppliers.
  • It is easy and automatic source of finance for the firms.

Disadvantages

  • The supplier may refuse to give discounts or completely stop trade with the business if payments are not met.
  • Suppliers see smaller, new business as unreliable, therefore they might not allow them to pay on credit.

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