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)


Write in Short

Short Answer▾

Why greater cash flow will have greater investment?


Cash flow refers to the revenue or expense streams that change a cash account over a given period. Cash inflows arise from one of three activities:

  • Financing activities
  • Operating activities
  • Investing activities

An entrepreneur always looks for the solutions that lead to long term goal and solutions that can aid in the optimal administration of the business.

Positive cash flow of a company indicates that cash is added to the cash reserves of the company which allows further to invest in the company, increases the pay-out money to shareholders or settlement of future debt payments. Companies having strong financial flexibility can use this opportunity to invest into profitable investments.

Question 34 (9 of 12 Based on Passage)


Write in Short

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-

How are financial goals related to the firm՚s mission and objectives?


The vital importance of the financial decisions to a firm makes it imperative to set up a sound and efficient organization for the finance functions. The ultimate responsibility of carrying out the finance functions lies with the top management. Board of director directly controls a department to organize financial activities.

The reason for placing the finance functions in the hands of top management may be attributed to the following factors:

  • Financial decisions are crucial for the firm. The firm՚s growth and development are influenced by the financial policies framed by the government.
  • The financial actions determine the solvency of the firms. At no cost a firm can afford to threaten its solvency
  • Centralization of finance functions can result in a few economies to the firm. For example, the firm can save in terms of interest on borrowed funds, can purchase fixed assets etc.

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