Working Capital Management - Assignment Example

Chapter 19: Quiz Problem Working Capital Management: Indicate how each of the following six different transactions that Dynamic Mattress might make would affect (i) cash and (ii) Net Working Capital: 1. Paying out a $2 million cash dividend: Answer: Payment of dividend will entail a decrease in cash balance and a corresponding decrease in the Net Working Capital by $2 million. There is, however, no effect on Net Working Capital since the decrease in current asset will be set off by a decrease in current liability. 2. A customer paying a $2,500 bill resulting from a previous sale: Answer: The transaction will result in an increase in cash by $2,500. However, there will not be any change in the Net Working Capital because the cash has come in by means of conversion of an already existing asset in the form of payments to be received toward credit sales. 3. Paying $5,000 previously owed to one of its suppliers: Answer: The transaction will reflect in the accounts by a decrease in cash balance by $5,000. However, this will have no effect on Net Working Capital since both current liability and current asset will decrease. 4. Borrowing $1 million long-term and investing the proceeds in inventory: Answer: There will be no change on cash position though two transactions will take place. Net Working Capital will increase by 1 million. 5. Borrowing $1 million short-term and investing the proceeds in inventory: Answer: Again, this will not involve any change in cash. Also, there will be no effect on Net Working Capital since both current liability and current asset will increase.  6. Selling $5 million of Marketable Securities for cash: Answer: The cash in hand will increase by $5 million. However, there will be no change in Net Working Capital as the transaction involves only the conversion of an already existing asset from one form to another. Chapter 19: Practice Problem 14: Forecasting Payments: If a firm pays its bills with a 30-day delay, what fraction of its purchases will be paid for: in the current quarter; and in the following quarter? What if its payment delay is 60 days? Answer: 1/6 of its purchases (2/12); ¼ for the next quarter, in case of 30-day delay and 1/12 for the first quarter and ¼ for the subsequent quarter if payment delay is 60 days. Chapter 20: Quiz Problem 4: Lock Boxes: Anne Teak, the financial manager of a furniture manufacturer, is considering operating a lock-box system. She forecasts that 400 payments a day will be made to lock boxes with an average payment size of $2,000. The banks charge for operating the lock boxes is $.40 a check. The interest rate is .015 percent per day. If the lock box saves 2 days in collection float, is it worthwhile to adopt the system? Answer: The savings in interest for 2 days will be $240. Operating cost of lock box is 400 x .40 = $160. Thus, if the speculated number of transactions occurs, they stand to save $90. What minimum reduction in the time to collect and process each check is needed to justify use of the lock-box system? Answer: 133.33 days Exercise 7-17 Assessing How Well Companies Manage Their Receivables: Assume that Hickory Company has the following data related to its accounts receivable: Particulars 2005 2006 Net Sales $ 1,425,000 $1,650,000 Net Receivables: i) Beginning of the Year ii) End of the Year 375,000 420,000 333,5000 375,000 Use these data to compute accounts receivable turnover ratios and average collection periods for 2005 and 2006. Based on your analysis, is Hickory Company managing its receivables better or worse in 2006 than it did in 2005? Answer: 2005:  Net Credit Sales/Average Debtors: 1425000 / (375000+420000) / 2 = 3.58 Collection Period = 12 / 3.58 = 3.35 2006: Net Credit Sales/Average Debtors: 1650000 / (333500+375000) / 2 = 4.65 Collection period = 12 / 4.65 = 2.58 From the above data analysis, it becomes evident that the company has been able to manage its receivables better during 2006 than in 2005. Case 7-3 Credit Policy Review: The president, vice president, and sales manager of Moorer Corporation were discussing the companys present credit policy. The sales manager suggested that potential sales were being lost to competitors because of Moorer Corporations tight restrictions on granting credit to consumers. He stated that if credit policies were loosened, the current years estimated credit sales of $3,000,000 could be increased by at least 20% next year with an increase in uncollectible accounts receivable of only $10,000 over this years amount of $37,500. He argued that because the companys cost of sales is only 25% of revenues, the company would certainly come out ahead. The vice president, however, suggested that a better alternative to easier credit terms would be to accept consumer credit cards such as VISA or MASTERCARD. She argued that this alternative could increase sales by 40%. The credit card finance charges to Moorer Corporation would be 4% of the additional sales. At this point, the president interrupted by saying that he wasnt at all sure that increasing credit sales of any kind was good thing. In fact, he suggested that the $37,500 of uncollectible accounts receivable was altogether too high. He wondered whether the company should discontinue offering sales on account.   With the information given, determine whether Moorer Corporation would be better off under the sales managers proposal or the vice presidents proposal. Also, address the presidents suggestion that credit sales of all types be abolished. Answer: As per the sales manager’s proposal, the sales can be increased from 3,000,000 to 3,600,000 in the event that the company decides to relax the credit policies. By the time the uncollectible accounts receivable will increase from 37500 to 47500 i. e 1.25% of sales to 1.32% of sales, which is not a good indication. As per the vice president’s proposal, the sales can be increased from 3,000,000 to 4,200,000. This will also entail additional financial implication of 48000 i. e on 1.14% on sales. Since it is better than the proposal of sales manager this seems a more viable proposition. In contrast to both, the proposal of the President does not seem advisable since the cost of sales is only 25% and the rest is contributing towards fixed costs .Hence stopping of credit sales is not advisable as it will deprive the company of a major source of generating sales. Problem 21-5 JIT Inventory: The president of Penman Corporation, John Burton, has asked you, the companys controller, to advise him on whether Penman should develop a just-in-time (JIT) inventory system. Your research concludes that there is a high cost associated with inventory storage facilities; that inventories use a large portion of the companys cash flow; and that because of the nature of the inventory, there is a significant amount of shrinkage. Research also shows that neither of Penmans two competitors uses a JIT inventory system. Most of Penmans employees are trained to do only one job and belong to a local union. The union is strong and, in the past, has opposed major production changes. The union believes major changes will result in the loss of union employees jobs. Your research indicates that Penmans major production item (a fairly new product in the market) should continue to have strong sales growth. Required: 1.   Using the information provided, advise John Burton to either continue the present system or work to develop a JIT inventory system. Considering the above points it is better to develop a JIT inventory system Assume John decides to develop an inventory management system. He plans to evaluate the system after one year. List at least four possible performance measures John could use to evaluate the effectiveness of the system. Describe what information these measures would provide John. The JIT system is designed to keep continuous check on inventory and to entire smooth flow of production by ensuring the ready availability of materials at the work station itself without having to use warehousing facilities. Considering the nature of the problem that a large portion of working capital of M/s Penman Corporation is locked up in inventories, and the fact that this has resulted in a dearth of working capital, it is advised to design and install a JIT inventory System. The company may consider four performance indicators of inventory control, which, if properly implemented, can increase the efficiency of Inventory management. Re-order level: is the stock level at which the fresh orders for the stocks has to be placed. This level is also called the Danger Level, below which stocks should not be allowed to fall, since in that case, there would be shortage of materials at the shop floor and production would suffer. The levels at which stocks have to be replenished by Penman Corp. is called the Re-order level. Minimum Level: The minimum Level is the stock level which indicates that the stocks have reached its lowest levels. However, at this stage, it may be desirable to place Orders for fresh stocks. The information it provides to Mr. John is that there may be a future dearth of materials if orders are not placed on time. Maximum Level: The maximum Level is when the stock of items has reached its highest point. It would be fatal for stocks to go beyond this point. The company has to ensure stocks belonging to this category are regularly sent for production process. It is also to be ensured that non-moving & slow-moving stocks are not a part of Maximum Stocks; otherwise, there is a risk of obsolescence and increased inventory carrying costs. Average Costs: It represents the ideal stock levels that have to be maintained, especially with the JIT Inventory system which Penman Corporation has decided to develop and implement. It represents the level at which smooth inventory is ensured, neither too high to increase carrying costs, nor too low to create shortages for Production. Read More