FINANCIAL MANAGEMENT

MODULE OVERVIEW
Lecture 1
1. Introduction to Financial Management
Academic context of financial management
The Environment of Financial Management
Fundamental objectives of Financial Management
Role of the Financial Manager
2. Financial Statement Analysis
3. Management of working capital
Management of working capital – Inventory
Management of working capital – Receivables and Payables
Management of working capital – Cash
4. Investment Appraisal
Investment appraisal – methods
Relevant cash flows for DCF
Discounted cash flow – further aspects
Investment appraisal under uncertainty

5. Business Finance and Business Valuations

Sources of finance – equity
Sources of finance – debt
Capital structure and financial ratios
Sources of finance – islamic finance
The valuation of securities – theoretical approach
The valuation of securities – practical issues
The cost of capital

When (and when not!) to use the WACC for investment appraisal

The cost of capital – the effect of changes in gearing

Capital asset pricing model

CAPM and MM combined

6. Risk Management

Forecasting foreign currency exchange rates

Foreign exchange risk management

Interest rate risk management

The treasury function

FINANCIAL MANAGEMENT

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OVERVIEW OF FINANCIAL MANAGEMENT
Introduction

This module is essentially about financial management by business enterprises

It deals with the issues facing a financial manager who has to manage the funds
of investors

The decisions required in order to ensure the growth of the business enterprise,
and therefore of the funds invested, form the core of financial management.

The success of any business enterprise depends on the strategic choices which
are made with regard to a vast spectrum of issues. The issues which are the focus
of the financial management function relate to the sources and uses of the funds.

The criterion used to measure the effectiveness of the financial management

function is the increment in the claims against the value of the business
enterprise by investors seeing a run on their invested capital

Academic context of financial management

Financial management relies heavily on allied disciplines such as economics and

accounting. It is essentially an applied disciplined which is approached from the
perspective of the financial manager of a business enterprise

Because of the existence of a securities exchange, a market on which shares of

companies are traded, we tend to use the listed company as the appropriate
enterprise for developing the principles of financial management. But such
principles are applicable to all types of business enterprise

1. Links with Economics

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  Financial management does not take place in a vacuum – it occurs in the
context of a specific national and international economy

 A knowledge of the fundamental principles of economics and some

understanding of interaction of economic forces, is therefore essential for
the student of financial management

 So the astute financial manager is aware of the impact of economic

indicators such as the gross domestic product, the balance of payment, the
foreign exchange rates, the inflation rate, and the domestic interest rates

 Deeply rooted in economics issues is the fundamental objective of making

the best use of scarce resource. In financial management the scarce
resource is financial capital. The financial manager is tasked with the
responsibility of making the best use of this resource

2. Links with accounting

 Generally accepted accounting practice is applied to the financial
statements of a public company to supply standardized company financial
information to the public
 This information together with any other relevant information is used by
investors to place values on the shares of a the company
 The financial manager will be required to analyses and interpret accounting
data. This will be used in an forward-looking perspective as the source of
financial management decisions

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 FROM ECONOMICS TO FINANCIAL MANAGEMENT

ALL SOURCES OF KNOWLEDGE

Many other Many other

disciplines disciplines

ECONOMICS

How do individuals/organisations/countries make the best

use of scarce resources

Financial Management

How does the financial manager use best practice to add

value to capital received in the form of debt and equity and
thereby creaste wealth?

The financial Manager

Measured by the generic formular for adding value

over one year time period.
Return = income/capital

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The environment of financial management

Financial management is practiced in a dynamic environment. A thorough

knowledge of the economic systems and principles operating in the environment
is essential

Individuals and governments across the world have differing value systems.
Accordingly, ideologies vary considerably between nations

The economic environment which economic activity takes place depends upon
the people who inhabit the country, the resources available within the country,
and the systems designed to promote economic activity. We need to consider
these factors before attempting to apply financial management principles within
the operating environment

Fundamental objectives of Financial Management

Objectives which are relevant in financial management center around

maximizing some variable, such variable and financial management objectives
could be:

 Profit
 Share price
 Investor wealth
 Company growth

We can accept that, in general, investors have rational expectations regarding

the future. It is often possible to quantify such future expectation and express
them as a single current value. Much of the discipline of financial management is
based on this concept, often referred to as the discounting of a series of expected
future cash flows so that they may be expressed in a single aggregated present
value. The question of which variable to maximize must therefore be addressed

In context of above, financial management focuses on decisions on the allocation

of scarce resources in most appropriate way

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The two variables on which financial management focuses as primary input in
decision making are Expected Return and Perceived Risk

Other Goals of Financial Management

Some of the goals include:

 Survive
 Avoid financial distress and bankruptcy
 Beat competition
 Maximize sales or market share
 Minimize costs

The Finance Manager

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Having placed the environment and objectives of financial management into
perspective, we turn to the role of the financial manager. Once we have defined
what the role of the financial manager is, we then explore the principles and
theories which are commonly used for effective financial management.

Two primary roles are:

a) To pursue wealth-creating investment opportunities

b) To find funds to finance the investment

The role of the Financial Manager

Operating Capital Markets

Assets: a) Equity
i) Non current b) Debt
ii) Current

Explores Explores
investment FINANCIAL financial
opportunities oportunities and
and makes MANAGER makes financing
invesment decisions
decisions

Financial Assets Money Markets

Balance Sheet showing investment and financing decisions

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 SUMMARISED BALANCE SHEET OF A LISTED
Investment Decisions COMPANY AT FINANCIAL YEAR END Financing Decisions

NON CURREN ASSETS $(m) SHAREHOLDER EQUITY $(m)

Property at cost 120 m Ordinary shares 50
Equipment at depreciated cost 130 Retained incom 180
Vehicle at depreciated cost 100 Non distributable reserves 20

CURRENT ASSETS 150 LONG TERM LOANS 200

Inventory - finished product 45 Loan from Devbank 120
Inventory - other 20 11% secured debentures 80
Work-in-progress 25
Debtors 50 CURRENT LIABILITIES 50
Cash resources 10 Creditor 35
Short term loans 10
Accruals 5

500 500

Financial Manager – Some key concepts

Imagine you are starting your own company

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No matter what type of company you start, you will have to answer the following
three questions in one form or another:

i) What long term investments would you take? Ie, what line of business
will you be in and what sort of buildings, machinery and equipment will
you need?
ii) Where will you get the long term financing to pay for your investments?
Will you retain the profits you make,
Will you bring in other owners or
Will you borrow the money?
iii) How will you manage your everyday financial activities, such as
collecting from customers and paying suppliers?

In most set ups the owners of the business (shareholders) are usually not directly
involved in making business decision, but delegate and an official, the Finance
Manager, who would be required to provide answers to the above 3 questions

The Financial Management Function is normally headed by a Finance Director or

Financial Controller and manages activities all related to the 3 questions and will
include:

a) Cash management
b) Credit management
c) Capital expenditure management
d) Financial planning
e) Record keeping, including: Cost accounting; Financial accounting MIS

FINANCIAL MANAGEMENT
OVERVIEW OF FINANCIAL MANAGEMENT
The Finance Management Decisions

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The Finance Manager, as mentioned above, is concerned with 3 questions:

Capital Budgeting

Firm’s long term investments:

The process of planning and managing a firm’s long term investments is

called Capital Budgeting
 In Capital Budgeting the Finance Manager tries to identify investment
opportunities that are worth more to the Firm than they cost to acquire
 I.e, the value of cash flow generated by the asset exceeds the cost of
that asset
 Concern not only on how much cash investments generate, but also
with when the cash flows will be received, ie
 Evaluating the size, timing and risk of future cash flows is the essence
of Capital Budgeting

FINANCIAL MANAGEMENT
OVERVIEW OF FINANCIAL MANAGEMENT
Capital Structure

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Second Finance Manager’s concern is “which ways the firm can obtain and
manage the long term financing it needs to support long term investments, ie the
Firm’s Capital Structure

This refers to the specific mixture of long term debt and equity the firm uses to
finance operations. Specifically, the Finance Manager has 3 concerns wrt to
Capital Budgeting:

 How much should the Firm borrow, ie what is the best mix of debt and
equity? As this will affect both risk and value of the Firm
 What are the least expensive sources of funds for the Firm?
 Decision on exactly how and where to raise the money, as there are
costs associated with raising money

Working Capital Management

Term Working Capital refers to a Firm’s short term assets, such as inventory, and
its short term liabilities, such as money owed to suppliers

Management of working capital ensures that the Firm a has sufficient resources
to continue its operations and avoid costly interruptions. Normal questions in
working capital management include ;

 How much cash and inventory should we keep on hand?

FINANCIAL MANAGEMENT
OVERVIEW OF FINANCIAL MANAGEMENT
 Should we sell on credit? And if so, on what terms, and to whom will

we extend that credit?

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  How will obtain any needed short term financing? Ie, we will

purchase on credit of borrow short term

FINANCIAL MANAGEMENT
FINANCIAL STATEMENT ANALYSIS
1. INTRODUCTION

Any analysis of a firm, whether by management, investors, or interest parties,

must include an examination of the company’s financial data

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The most readily available source of this information is the firm’s annual report

An Annual Report normally consists of:

 A balance sheet
 An income statement
 A directors’ report
 An auditors’ report

The formation in the AR will be both Descriptive and Quantitative. The

descriptive statements include: the chairman’s report, directors’ report, the
auditors’ report, and these reports describe the firm’s operating results during
the past year and discusses new developments that will take effect during the
future periods.

Quantitative statements consists mainly of the income statement, the balance

sheet, and the statement of cash-flows. Collectively, these statements give an
indication of the firm’s performance and its current financial position

FINANCIAL MANAGEMENT
FINANCIAL STATEMENT ANALYSIS
2. OBJECTIVES OF FINANCIAL STATEMENT ANALYSIS

The overall objective of financial statement analysis is to examine a firm’s

financial position and returns in relation to risk, with a view to forecasting the
firm’s future prospects. In examining the specific objectives of analysts we need

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to identify different categories of analysts and their information requirements.
The analysts include:

 Equity investors
 Credit grantors
 Management
 Employees
 Acquisition and merger analysts
 Auditors
3. LIMITATIONS OF ACCOUNTING DATA

It must be remembered that financial statement analysis is dependent upon

accounting data. While the importance of accounting data in financial decision –
making should not be under-estimated, there are certain limitations. If these
limitations are borne in mind, the correct perspective can be applied to the
analysis.

The major limitations of accounting date are as follows:

Monetary expression: accounting data contain only information that can be

expressed in terms of monetary value. Hence any attribute that cannot be
expressed in terms of $ would be ignored. Accounting data make no effort to
value for instance its management team and all human resources

Simplification and summarization – simplification process in recording highly

complex and diverse economic events inevitably result in a loss of some clarity
and detail that may have been useful to the financial analyst

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Estimation, judgment, and accounting policies – a large proportion of the
financial data contained in financial statement is based on subjective rather than
objective criteria. Subjectivity arises from the estimation and judgment of the
accountants who prepare the financial statements. If different accounting
policies are used, the financial statements of different firms may not be uniform
or comparable.

Inflation – While the disadvantage of monetary expression is the exclusion of

information that cannot be expressed in $ value, the advantage is that it provides
a common denominator which enables comparison between such diverse assets
as investment and raw material inventory. Inflation leads to a decline in the
PPower and so reduces the standard of value of the currency. These changes are
not necessarily reflected in the financial data

4. APPROACHES TO FINANCIAL STATEMENT ANALYSIS

The analyst has a variety of techniques available for analyzing financial

statements and can choose the one best suited to a specific purpose:

 Comparative financial statements and trend analysis

 Accomplished by setting up BS, IS and CFS side by side and reviwig
the changes that have occurred from year to year
 The most important factor revealed by comparative financial
statements is the trend – which indicate the direction of changes,
the rate of change and the amount of change.
 Meaningful trend can be established if financial information is
available for a number of years – normally 5 years is minimum and 10
years ideal

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  Index analysis
 Is similar to comparative statements except that a base year is
chosen and all values for that year are expressed as 100%
 All the following years are then expressed in terms of %age
calculated on the base year
 Common size analysis
 It is often ideal to show individual items as a proportion of the total
group.
 For instance, in the IS, turnover is commonly used as the base, and
everything else expressed as a %age of sales
 Since a %age can change with either a change in the absolute
amount of the investment or change in the total of the assets which
it is part, the interpretation of common size analysis requires an
examination of the actual figures and the basis on which they are
compared

 Ratio analysis
 For a ratio to be effectively interpreted, it needs to be either
compared with historical ratios to identify trends, or with industry
ratios, or with management’s goals and standards, and it must be
evaluated in the context of associated ratios
 Ratios may be categorized into 6 groups:

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  Liquidity ratios
 Asset management rations
 Debt management ratios
 Profitability ratios
 Cash flow ratios
 Market value ratios
a) Liquidity
A major concern of any analyst is whether the firm will be able to
meet its maturing financial obligations
Best known measures of liquidity are the Current and the Quick
Ratios
Current Ratio
Current assets/current liabilities
 Current assets include cash, accounts receivable,
inventory, which accrued liabilities include accounts
payable and accrued expenses
 As rule of thumb, ratio should be in region of 2:1 as
benchmark

Quick ratio (or Acid test)

Current assets less inventory/current liabilities

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  As it normally takes longer to translate inventory into cash,
it is useful to measure firm’s ability to pay off short term
obligations without relying on the sale of inventories
 The rule of thumb for a quick ratio is 1:1

Asset management ratios

 This group of ratios is designated to measure how

effectively management is utilizing the company’s assets.
 In particular, the asset management ratios seek to
ascertain whether the investment in assets is justified in
relation to activities as measured by turnover

Inventory turnover

Cost of sales/ inventory

Issues to consider are:

 Excessive inventories are unproductive and represents

investment at low or zero return
 Ratios are at point of time – in reality inventory levels
vary and it will make sense to use average levels rather
than end of year figures

Average collection period

Represents the average length of time that the firm wait

after making a sale before receiving the cash

Accounts receivable/(sales/365)

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 Fixed asset turnover

The fixed asset turnover indicates the utilization of plant,

machinery and equipment relative to operating levels as
reflected by turnover

Sales/(fixed assets)

Total asset turnover

This measures the utilization of all operating assets in

relation to turnover:

Sales/operating assets

Debt management ratios

Debt ratio

 Measures the percentage of total funds provided by

creditors
 Total debt/ total assets

Times interest earned

 Measures the extend to which earnings can decline

without causing financial losses to the firm and creating
an inability to meet the interest cost
 The before tax figure is used
 EBIT/interest
Debt Equity

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 Similar to debt ration except that it measures the ratio of total
liabilities to total equity

Total debt/ total equity

It indicates the extend that debt is covered by shareholders’

funds

Profitability ratios

As profitability is the result of a large number of policies and decisions, the

profitability rations will show the combined effect of liquidity, asset management
and debt management on operating results

Gross profit margin on sales = GP/ sales

Profit margin on sales = net profit (EAIT)/sales

Return on total assets (ROA) = EBIT/total assets

Return on equity = earnings after tax/total shareholder funs

Cash flow ratios

Measure the cash flow generated from trading activities in relation to total debt

Cash flow from operations/total debt

Market value ratios

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  These ratios indicate the relationship of the firm’s shares price to dividends
and earnings.
 They are strong indicators of what investors think of the firm’s past
performance and future prospects. If the firm’s liquidity, asset
management, debt management and profitability ratio are all good,
investors will value the shares of the firm highly and market value ratios
will be high
 Dividend yield = dividend per share/price per share
 Earnings yield = earnings per share/price per share
 Price earnings ratio = price per share/earnings per share
 Dividend cover = earnings per share/dividend per share

Example – Dome ltd

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Dome Ltd: Income Statement for the year ended 3 December

20.2 20.1
$m $m
Turnover 2,478 1,999
cost of sales 1,287 1,055
Gross profit 1,191 944
Marketing and distributiom costs 403 333
Administration exp 187 153
Other operating costs 153 101
Earnings beofe interst and taxation 448 357
Interest payable 72 68
Earnings after interest and before tax 376 289
Taxation 112 86
Earnings after tax 264 203
Dividends 88 80
Retained earnings for the year 176 123
Retainined earnings at beginning of year 456 333
Retained earnings at end of the year 632 456

earnings per share 0.528 0.406

Dvdents apre share 0.18 0.16
Divudebt cover 3.00 2.54
Cash flow from operations 219 242

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Dome ltd: Balance sheet as at 31 December 20.2 20.1
$m $m
Share capital (500m prd shares ar 100c each) 500 500
Retained income 632 456
Total sahreholder funds 1,132 956
Long term borrowings 580 530
1,712 1,486
Employed as:
Fixd assets 1,388 1,218
Current assets 472 413
Accounts receiable 201 188
Cash and bank 21 20
Invetories 250 205
Current Liabilities 148 145
Accounts payable 108 110
Shor term borrowings 40 35
Net current assets 324 268
1,712 1,486
$ $
Market price 2.80 2.50

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FINANCIAL MANAGEMENT
WORKING CAPITAL MANAGEMENT

Introduction

 Working capital is essential for all business activity. It comprises three

primary assets:
 Inventory;
 Accounts receivables; and
 Cash
 These, together with fixed assets and investment, comprise the most
significant portion of the capital asset base of a company, on which a
required rate of return must be earned
 The amount of funds invested in working capital reflects the strategic
operating plan of the business
 It is always highly sensitive to the performance of the business and to the
economic conditions
 In times of slump in economy and demand shrinking, inventory
holdings increases
 In times of economic recession, debtors may take longer to settle
accounts, with resultant increase in investment in accounts receivable
 Changes in one component working capital will affect another
 Working capital must therefore be carefully planned, continuously
monitored, and effectively managed

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FINANCIAL MANAGEMENT
WORKING CAPITAL MANAGEMENT

Definitions

a) Working capital refers to current assets while;

b) Net working capital (or net current assets) refers to current assets less
current liabilities
c) Working capital policy refers to basic policy decisions on the optimal level
of investment in, and the optimal financing of, current assets
d) Working capital management involves the administration, with policy
guidelines, of current assets and current liabilities

Objectives of working capital policy

Certain levels of working capital are required for the firm to operate efficiently.

Should the level of working capital be too low, the firm would be exposed to
additional risk

 Low levels of inventory increase the likelihood of stock-outs with resultant

loss of profit margins
 Low levels of debtors, as a result of stringent collection policies, may drive
debtors to purchase elsewhere
 There is an opportunity cost where investment in working capital is too
high
 So, in formulating a working capital policy, management need to find a
level of investment in working capital where the return generated and the
exposure to risk are finely balanced

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FINANCIAL MANAGEMENT
WORKING CAPITAL MANAGEMENT

Working capital cycle

Knowledge of the working capital cash cycle of a particular company is

essential in establishing a working capital policy for the company

A typical cycle of a manufacturing company is as follows:

๏ Firm orders and then receives the raw materials which are
required for production
๏ this transaction will either reduce available cash or lead to
increase in accounts payable
๏ Labor is used to convert the raw material into finished goods and
will lead to an reduction in cash
๏ The finished goods are then sold. Credit sales will increase
accounts receivable
๏ Finally, the cycle is completed when cash is received from the
debtors. At this stage the firm is ready to repeat the cycle

FINANCIAL MANAGEMENT

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 WORKING CAPITAL MANAGEMENT

Purchase transfer finished goods credit sale cash received

raw materials to
materials factory
45 35 50 60

90 days
Creditors payment period Credit collection period

100 days
Period in which financing is required

Fig 1: The working capital cycle

From the fig, it can be seen that the cycle takes 190 days
(45+35+50+60) from start to finish. As the creditors payment period is
only 90 days, the financing is required for only 100 days

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FINANCIAL MANAGEMENT
WORKING CAPITAL MANAGEMENT

The days in invested in each component can be estimated using the

following accounting ratios:

Raw material inventory days = raw material inventory

purchases

Work in progress inventory days = WIP inventory

Cost of sales

Finished goods inventor days = Finished goods

Cost of sales

Debtors days = Debtors

Sales

Creditors days = Creditors

Purchases

How do you reduce the working capital cycle? (students to discuss)

 Reducing the time taken to covert raw materials into finished goods;
 Reduce the time taken to sell finished goods;
 Reducing the time taken to recover from debtors;
 Lengthening the time taken to pay creditors

In resorting to these actions, the effect would be to reduce the cycle.

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FINANCIAL MANAGEMENT
WORKING CAPITAL MANAGEMENT
Working Capital Policy

Working capital policy involves making two decisions:

 The appropriate level of investment in current assets, and

 How it should be used

There is a relationship between the level of working capital relative to the total
asset investment, and risk. Generally, it can be said that the greater the level of
working capital for a given level of output, the less risky the firm’s working
capital policy

The higher the working capital level, the risk of shortages which would disrupt
production or sales and lead to increased costs or deceased sales is reduced.
With high levels of inventory, the chances of running out of inventory is remote
and production is unlikely to be disrupted.

Likewise if there is a high level of cash on hand the firm is unlikely to be faced
with a sort term liquidity crisis, and the debtors’ credit terms can be extended to
prevent any loss in sales as a result of an overly stringent credit policy

However, there is an opportunity cost to reduce the risk. Should management be

conservative, the return will be less than if it is less risk-averse. The returns
associated with different working capital policies can be illustrated as below

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FINANCIAL MANAGEMENT
WORKING CAPITAL MANAGEMENT

Effect of working capitat on rates of returns

Working Capital Policy

Conservative Moderate Aggressive
$m $m $m
Sales 80 80 80
EBIT 6 6 6

Current assets 30 20 10
Fixed assets 20 20 20
50 40 30

Return on total assets % 12 15 20

It can be seen that conservative policy yields the lowest return as the firm has
acquired more assets than required to support sales

The optimum level of working capital lies somewhere between the conservative
and the aggressive

FINANCIAL MANAGEMENT

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 WORKING CAPITAL MANAGEMENT
Working Capital Finance Policies

a) Aggressive financing policy

short
term
financing

Permanent current assets

long
term
financing

Fixed Assets

The double arrow line above could lie below the line designated fixed assets,
indicating that a current assets plus part of the fixed assets are paid for by short
term financing. This will be a very aggressive policy and would result in net
current liabilities being disclosed in the balance sheet. It is worth noting that
some of the big retailer lie Pick & Pay reflects this policy in financial statements.

FINANCIAL MANAGEMENT

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 WORKING CAPITAL MANAGEMENT
As the company sales only for cash, spontaneous finance provided by creditors is
used to finance current and fixed assets

Whether the risk is acceptable will depend on the level of operating risk, the
volatility of sales, and the costs associated with short term finance

b) Conservative financing policy

$ short
term
financing

Permanent current assets long

term
financing

Fixed Assets

To guard against uncertainty, the firm makes an attempt to match working

capital investments wand financing maturities based on expected movements.
This is regarded as a moderate financing policy

FINANCIAL MANAGEMENT

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 WORKING CAPITAL MANAGEMENT

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i) The working capital (or operating) cycle which requires financing is the length
of time between payment for material entering into inventory and receipt of
the proceeds of sales
The table below gives information extracted from the annual accounts of
Gracelands Lt for the past three years:

Yr 1 Yr 2 Yr 3
$ $ $
Inventory - raw materials 108,000 145,000 180,000
Work inprogress 75,600 97,200 93,360
Finished goods 86,400 129,600 142,875
Purchases 518,400 70,000 720,000
Cost of sales 756,000 972,000 1,098,360
Sales 864,000 4,080,000 1,188,000
Debtors 172,800 259,200 297,000
Trade creditors 86,400 105,300 126,000

a) Calculate the length of the working capital cycle year by year (assuming
365 days in the year, and;
b) List possible actions that might be taken to reduce the length of that cycle,
and the possible disadvantages of each

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1. Faulty Manufacturing’s management is concerned about the way in which
their company will be financed. The three alternative plans that have benne
proposed are shown below

Plan 1 Plan 2 Plan 3

$ $ $
Total Current assets 2,250,000 2,250,000 2,250,000
Inventory 95,000 950,000 950,000
Fixed assets 4,000,000 4,000,000 4,000,000
Curent labilities (8%) 2,250,000 1,500,000 750,000
Long eterm debt (12%) 750,000 - 2,250,000
Ordinary shares 3,250,000 4,750,000 3,250,000

Irrespective of which plan is chosen, sales are expected to be $25million and

operating profits (EBIT) will be $4million. Assume a company tax rate of 50%

For each plan, calculate the following: current ratio, quick ratio, net working
capital

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2. Anjo Ltd is a largely family owned company, with twelve shareholders in
total. Whilst the long term plan involves making a rights issue in two years’
time, none of the current shareholders are imposition to inject new capital
into the company at present. Neither do they wish to issue shares outside the
current group of shareholders as they do not want to lose their collective
control of the company.

Extract from the recent financial statements of Anjo Ltd are as follows:

Income Statement
20X6 20X5
$000 $000
Revenue 15,600 11,100
Cost of sales (9,300) (6,600)
Gross profit 6,300 4,500
Administration exp (1,000) (750)
Profit before intest and tax 5,300 3,750
Finance cost (interest) (100) (15)
Profit before tax 5,200 3,735

Balance Sheet
Non current assets 5,730 5,400

Current assets
Inventory 3,000 1,300
Receivables 3,800 1,850
cash 120 900
6,920 4,050

Current Liabilities
Accounts payble 2,870 1,600
Overdraft 1,000 150
3,870 1,750

Total assets less current liab 8,780 7,700

All sales were on credit. Anjo has no long-term debt. Credit purchases in each
year were 95% of sales

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Anjo pays inters on its overdraft at an annual rate of 8%. The current sector
averages are as follows:

Inventory days : 90 days Receivables days : 60 days Payables days: 80 days

Required

a) Calculate the following ratio for each year and comment on your findings
i) Inventory days
ii) Receivables days
iii) Payables days

State the symptoms of overtrading and decide whether or of the company is

overtrading

b) Calculate the length of the cash operating cycle for each year and explain its
significance
c) Briefly discuss the importance of cash management
d) A factor has been offered to take over sales ledger administration and debt
collection for an annual fee of 0.5% of credit sales. A condition of the offer is
that the factor will advance Anjo 80% of the face value of its receivables at an
interest rate of 1% above the current overdraft rate. The factor claims that it
would reduce outstanding receivables by 30% and reduce administration
expenses by 2% per year if its offer were accepted.

Required:
Evaluate whether the factors offer is financially acceptable, basing your
answer on the financial information relating to 20X6

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