IGCSE Enterprise: Specimen Questions with Answers 32 - 33 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 32 (7 of 12 Based on Passage)

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Short Answer▾

“Internal cash flow can be used to finance investments in working capital without the need to raise costly external finance”

What is a cash flow statement?

Explanation

An analysis of cash flows is useful for short term planning. A firm needs sufficient cash to pay its debt maturing soon, to pay interest and other expenses and to pay dividends to shareholders. The firm can make projections of cash inflows and outflows for the near future to determine the availability of cash. This cash balance can be matched with the firm՚s need for cash during the period and accordingly arrangements can be made to meet the deficit or invest the surplus cash temporarily. A historical analysis of cash flows provides insight to prepare reliable cash flow projections for immediate future. A statement of changes in financial position on cash basis, commonly known as cash flow statement, it summarizes the causes of changes in cash position between dates of two balance sheets.

Question 33 (8 of 12 Based on Passage)

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Short Answer▾

“Managers should avoid negative effects on firm performance because of additional financing expenses”

Why is it important for a business to keep financial records?

Explanation

To achieve financial success, you will have to plan and work for it. Budgeting and maintain financial record are significant part of financial planning. Financial records may be maintained in the form of:

  • Trial balance
  • Profit and loss
  • Balance sheet
  • Cash flow statement
  • Receipt book
  • Petty cash book
  • Invoice book

Keeping financial records in a planned and organized manner is very important for the success of a business or organization. Whatever type of activity you are involved in or organization you are running, if money is involved you need to be able to keep a track of your financial activities. Well planned and organized financial records make it much easier for you to know how you are doing financially. Every organization is legally required to keep a financial track of its documents.