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WORKING CAPITAL MANAGEMENT

10 Spice Co has a two-stage trading process:

Stage 1: buy a large quantity of goods on credit

Stage 2: immediately sell them on credit at a profit
Which of the following will increase after Stage 1?
A Receivables and inventory
B Current assets and non-current liabilities
C Payables and cash
D Current assets and current liabilities

11 Which of the following might be associated with a lengthening working capital cycle?

A Higher net operating cash flow

B Decreasing depreciation expenditure
C Quicker inventory turnover
D Taking less time to pay suppliers

12 The following information has been calculated for D Co:

Trade receivables collection period 12 weeks
Raw material inventory turnover period 8 weeks
Work in progress inventory turnover period 4 weeks
Trade payables payment period 9 weeks
Finished goods inventory turnover period 8 weeks
What is the length of the working capital cycle?
A 17 weeks
B 23 weeks
C 25 weeks
D 41 weeks

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13 Lyrical Co is re-evaluating its inventory control policy. Its daily demand for wicker baskets
s steady at 50 a day for each of the 250 working days (50 weeks) of the year. The baskets
are currently bought weekly in batches of 300 from a local supplier for $2.50 each. The
cost of ordering the boxes from the local supplier is $75 per order, regardless of the size
of the order. The inventory holding costs, expressed as a percentage of inventory value,
are 28%.

What is the correct Economic Order Quantity?

A 896 boxes
B 949 boxes
C 1,268 boxes
D 1,793 boxes

14 Taco Co is considering the implementation of a revised receivables policy, which will

result in an increase in the average collection period from the current 60 days to 90 days.
This is expected to lead to a 20% increase in annual sales revenue, currently $960,000,
resulting in additional inventories and trade payables of $30,000 and $15,000
respectively. It is expected that all customers will take advantage of the extended credit
period.

What is the net increase in working capital investment that would result from the change in
policy, assuming a 360-day year?
A $31,000
B $95,000
C $113,000
D $143,000

15 A machine that was bought in January 20X4 for $66,000 and has been depreciated by
$12,000 per year, is expected to be sold in December 20X6 for $35,000.

What is the net cash inflow (or outflow) that will appear in the cash budget for December
20X6?
A $5,000 inflow
B $5,000 outflow
C $35,000 inflow
D $35,000 outflow

16 Yellofish has an accounts receivables turnover of 12.5 times, an inventory turnover of

5 times and payables turnover of 9 times.

What is Yellofishs cash operating cycle (assume 365 days in a year)?

A 61.64 days
B 76.50 days
C 84.36 days
D 142.76 days

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17 A cash budget was drawn up as follows:

January February March
$ $ $
Receipts
Credit sales 30,000 21,000 24,500
Cash sales 20,000 14,500 16,000

Payments
Suppliers 13,000 14,200 17,800
Wages 4,600 2,300 3,000
Overheads 13,000 11,750 11,900

Opening cash 5,500

The closing cash balance for December is budgeted to be:
A $39,950 overdraft
B $47,050 overdraft
C $39,950 deposit
D $47,950 deposit

18 Net working capital is the difference between

A Shareholders investment and cash

B Total assets and total liabilities
C Non-current assets and non-current liabilities
D Current assets and current liabilities

19 A company has a quick ratio of 1.5 and a current ratio of 1.9. Industry averages are 1.0 for
the quick ratio and 2.0 for the current ratio.

Which of the following is likely to be true about the companys working capital position?
A The company has less inventory than other companies
B The company has more accounts receivable than other companies in the industry
C The company has less accounts receivable than other companies
D The company has more inventory than other companies in the industry

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WORKING CAPITAL MANAGEMENT

7 HOTTUBES
Hottubes Co is a small company specialising in the supply of high quality amplifier do-it-
yourself kits for sale to Hi-Fi enthusiasts. These include superior electronic components,
circuit boards and detailed instructions. Promotion is carried out through adverts in
electronics and Hi-Fi magazines. The company buys most of its components from a
specialist supplier in Hong Kong and the remainder from a few local suppliers.
The CEO (and founder) is very proud of the companys performance and recently made the
following comment.
'We have excellent products as seen in the recent rave reviews in a major consumer
electronics magazine. Our business has grown rapidly over recent years and we have good
profitability. We also have good liquidity with current assets easily covering current
liabilities. This is partly due to improved credit control over receivables. However, our Hong
Kong supplier demands payment at the end of each month for all items shipped in that
month'
As with many other small businesses, Hottubes uses its bank overdraft to finance working
capital and has no other longer term funding. The current overdraft rate is 1.0% per month
on the monthly outstanding balance.
Extracts from the management accounts for the last two years are as follows.
31 December 20X2 20X1
$000 $000
Sales 1,024 640
Cost of sales 640 400
Other expenses 132 81
Inventories
Components 300 208
Finished kits 220 96
Trade receivables 320 204
Trade payables 135 104
Other payables 31 30
Corporation tax due 63 40
Purchases for the year 776 490
Bank overdraft 180 100

Required:
(a) Calculate the length of the cash operating cycle of Hottubes in both 20X1 and 20X2
(10 marks)
(b) Discuss the benefits of centralising cash management in a treasury department for
group companies. (5 marks)
(Total: 15 marks)

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8 FRANTIC PT I
Frantic Co is a specialist car manufacturer and is a member of a group of companies that
provides a range of automobile products and services. It is currently facing difficulties in the
management of its working capital and the financial controller of Frantic Co is to investigate
the situation with a view to optimising supplier payments and customer discounts to ease
projected cash flow problems.
Payables
Payables arise only for engine purchases. Engine suppliers have offered an early settlement
discount of 1.5% if invoices are settled within one month of delivery. If the settlement
discount is not taken, normal payment terms of two months from delivery apply.
Receivables
The cars are sold at $42,500 each and unit sales are equal to the units produced in each
month. 50% of the cars are made to order and payment is on a cash on delivery basis. The
remaining cars are sold to specialist retailers who take two months credit. Frantic is
considering offering the specialist retailers a 2% discount for payments made within one
month of sale. It is expected that 75% of the retailers would take up the offer.
The company uses its bank overdraft rate of 15% as its discount rate.

Required:
(a) Calculate:
(i) if it is beneficial for Frantic to change from a two month payment period to a
one month payment period for payables (3 marks)
(ii) if it is beneficial for Frantic to implement the 2% discount for receivables.
(2 marks)
(b) Write a report to the Managing Director which identifies:
how cash flow problems can arise
the methods available for easing cash shortages
the techniques, besides cash budgeting, that could be used to monitor and
manage cash resources (10 marks)
In all your answers clearly state any assumptions you make. (Total: 15 marks)

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9 FRANTIC PT II
Frantic Co is a specialist car manufacturer and is a member of a group of companies that
provides a range of automobile products and services. It is currently facing difficulties in the
management of its working capital and the financial controller of Frantic Co is to investigate
the situation with a view to optimising supplier payments, inventory ordering and
receivables discounts to ease projected cash flow problems.
Payables
Payables arise only for engine purchases. Engine suppliers have offered an early settlement
discount of 1.5% if invoices are settled within one month of delivery. Frantic has decided to
accept its suppliers offer.
Inventory
Frantic has a budgeted production of 800 cars for the year. The most expensive bought-in
components for the cars are engines. Other components are either made in-house or are
minor items which are bought-in but which do not require special inventory management.
Engine purchase prices are subject to quantity discounts according to the following
schedule:
Order quantity Order quantity
049 units 0%
50249 units 2%
above 249 units 3%
Other details are:
Engine price (before discounts): $1,300
Inventory holding costs per annum
(as a percentage of engine costs): 22%
Delivery costs per order: $1,200
There is zero lead-time on engine orders.
Receivables
The cars are sold at $42,500 each and unit sales are equal to the units produced in each
month. 50% of the cars are made to order and payment is on a cash on delivery basis. The
remaining cars are sold to specialist retailers who take two months credit.
Other factors
A budget forecast is to be prepared for a six-month period. Other variable costs (including
the other components) represent 65% of sales value and are payable immediately. Fixed
costs are $18,000 per month for the first three months, rising to $22,000 per month
thereafter. The first instalment of $3.2 million for a major re-tooling operation will be paid
in month three of the budget forecast.
Assume that the opening bank overdraft is $25,000 and that there are payables outstanding
to the value of $97,500 which will be paid in the first month of the budget plan. It is
expected that receivables payments of $1,062,500 will be received in each of the first two
months.
The company uses its bank overdraft rate of 15% as its discount rate. Assume one month
comprises 30 days, that no opening inventory of engines is held and that production is
evenly spread throughout the year.

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Required:
(a) Calculate the optimal ordering policy for engines (8 marks)
(b) Payables are commonly used as a major source of short-term finance.
Explain what factors might be taken into account by an enterprise in deciding the
extent to which it should make use of credit from suppliers. (7 marks)
(Total: 15 marks)

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11 SPECIAL GIFT SUPPLIES INC

Special Gift Supplies Inc is a wholesale distributor of a variety of imported goods to a range
of retail outlets. The company specialises in supplying ornaments, small works of art, high
value furnishings (rugs, etc) and other items that the chief buyer for the company feels
would have a domestic market. In seeking to improve working capital management, the
financial controller has gathered the following information.
Months
Average period for which items are held in inventory 3.5
Average receivables collection period 2.5
Average payables payment period 2.0

Required:
(a) Calculate Special Gift Supplies funding requirements for working capital measured
in terms of months. (3 marks)
(b) In looking to reduce the working capital funding requirement, the financial
controller of Special Gift Supplies is considering factoring credit sales. The
companys annual revenue is $2.5m of which 90% are credit sales. Irrecoverable
debts are typically 3% of credit sales. The offer from the factor is conditional on the
following:
(1) The factor will take over the sales ledger of Special Gift Supplies completely.
(2) 80% of the value of credit sales will be advanced immediately (as soon as
sales are made to the customer) to Special Gift Supplies, the remaining 20%
will be paid to the company one month later. The factor charges 15% per
annum on credit sales for advancing funds in the manner suggested. The
factor is normally able to reduce the receivables collection period to one
month.
(3) The factor offers a no recourse facility whereby they take on the
responsibility for dealing with irrecoverable debts. The factor is normally
able to reduce irrecoverable debts to 2% of credit sales.
(4) A charge for factoring services of 4% of credit sales will be made.
(5) A one-off payment of $25,000 is payable to the factor.
The salary of the Sales Ledger Administrator ($12,500) would be saved under the
proposals and overhead costs of the credit control department, amounting to
$2,000 per annum, would have to be reallocated. Special Gift Supplies cost of
overdraft finance is 12% per annum. Special Gift Supplies pays its sales force on a
commission only basis. The cost of this is 5% of credit sales and is payable
immediately the sales are made. There is no intention to alter this arrangement
under the factoring proposals.
Required:
Evaluate the proposal to factor the sales ledger by comparing Special Gift Supplies
existing receivables collection costs with those that would result from using the
factor (assuming that the factor can reduce the receivables collection period to
one month). (12 marks)
(Total: 15 marks)

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12 REPORT ON WORKING CAPITAL

Write a report to the financial controller of a company that outlines:
(i) how a credit control department might function
(ii) the benefits of factoring and
(iii) how the financing of working capital can be arranged in terms of short and long-
term sources of finance.
In particular, make reference to: the financing of working capital when short-term
sources of finances are exhausted, and the distinction between fluctuating and
permanent current assets. (15 marks)

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14 H FINANCE
H Finance is prepared to advance 80% of D Cos sales invoicing, provided its specialist
collection services are used by D Co. H Finance would charge an additional 0.5% of D Cos
revenue for this service. D Co would avoid administration costs it currently incurs
amounting to $80,000 per annum.
The history of D Cos receivables ledgers may be summarised as follows:

20X1 20X2 20X3

Revenue $000 78,147 81,941 98,714
% receivables at year end 17 20 22
% receivables of 90+ days (of revenue) 1.5 2 2.5
Bad debts $000 340 497 615

D Co estimates that the aggressive collection procedures adopted by the finance company
are likely to result in lost revenue of some 10% of otherwise expected levels.
Currently, each $1 of revenue generates 18 cents additional profit before taxation. D Co
turns its capital over, on average, three times each year. On receipt by H Finance of
amounts due from D Cos customers, a further 15% of the amounts are to be remitted to
D Co.
The cheapest alternative form of finance would cost 20% per annum.

Required:
(a) Calculate whether the factoring of D Cos receivables ledger would be worthwhile
(8 marks)
(b) Explain how the factoring of sales invoicing may assist a firms financial
performance. (7 marks)
(Total: 15 marks)

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