Which of these is not a broad principle of cash management that helps ensure that a business remains solvent? Select one:
a. Collect cash owing from accounts receivable as quickly as possible
b. Pay accounts payable just before the due date rather than when the statement is first received
c. Buy all capital equipment on hire purchase
d. Invest any cash that is surplus to requirements to earn a return for the business
The correct answer and explanation is:
The correct answer is c. Buy all capital equipment on hire purchase.
Explanation:
Cash management is crucial for ensuring a business remains solvent, meaning that it can meet its financial obligations as they come due. There are several broad principles of cash management that businesses adopt to maintain liquidity and avoid insolvency. Let’s look at each option in detail.
- Option a: Collect cash owing from accounts receivable as quickly as possible. This is a key principle of cash management. When a business is able to collect outstanding debts quickly, it enhances its cash flow, making more funds available to meet its own obligations. Slow collection of receivables can lead to cash shortages, which could impact day-to-day operations or result in the business being unable to pay its bills.
- Option b: Pay accounts payable just before the due date rather than when the statement is first received. This is another widely adopted cash management practice. By delaying payments until the last possible moment, businesses can hold on to their cash longer, which can be especially important if the business is facing short-term liquidity constraints. However, this needs to be balanced with maintaining good relationships with suppliers, as late payments may lead to penalties or damage the business’s reputation.
- Option c: Buy all capital equipment on hire purchase. This is not a good principle for cash management. Hire purchase arrangements can sometimes lead to high interest costs and tie up cash flow in fixed liabilities. While it may allow a business to acquire assets without a significant upfront cost, relying heavily on hire purchase for all capital equipment is not a sustainable cash management strategy. It could create cash flow problems, especially if the business faces economic downturns or needs to invest in other areas.
- Option d: Invest any cash that is surplus to requirements to earn a return for the business. This is a good cash management principle. If a business has surplus cash, it should seek to invest that cash to earn a return, rather than letting it sit idle. This can help the business generate additional income and improve overall financial performance.
In summary, buying all capital equipment on hire purchase is the least effective cash management strategy because it can lead to increased liabilities and less flexibility in the short and long term. Businesses should focus on strategies that improve cash inflow, reduce unnecessary liabilities, and make the best use of available resources.