Kandy

(b) Discuss the working capital objectives of liquidity and

profitability and the conflict between these objectives.

The objectives of working capital management are ensuring profitability and

liquidity at the same time. Profitability is gathering return for investors and
liquidity is being able to meet obligations when they fall due.

Keeping high level of current assets can ensure short term liablities will
meet. It will ensure liquidity. But liquid assets such as cash are not profitable,
liquid assets such as cash does not generate a high return. so, a high level of
current assets will reduce profitability of the company.

As there is a conflict between liquidity and profitability, there is no best

perfect level of current asset. it will be determined by every company for
itself.

(c) Explain the cash operating cycle and discuss its relationship with
the level of investment in working capital.

The cash operating cycle refers to the average length of time take by a
business to get back cash that after paying for an item of inventory. It
calculated by adding up the average inventory holding period and the
average trade receivable collection period and then deducting the average
trade payable payment period. Cash operating cycle measures the liquidity
of the business in terms of cash. A long cash operating cycle indicates a
lower level of liquidity. It may indicate liquidity problem as the business is
without cash for a long time.

The relationship of cash operating cycle with working capital is that, the
longer the cash operating cycle is, the more capital is invested in working
capital.

Guillermo

(b) Discuss THREE ways in which Guillermo Co could reduce its cash
operating cycle.

#### comment on the days ratio of the company ####

1. Improving credit control: the receivable collection period of the
company is 68 days which is more than twice of standard credit term
of 30 days. This is an indication of a very poor credit control system. As
there is no credit control function, establishment of one can boost
chasing up debt.
2. Decreasing raw material holding period: the raw material holding
period of 20 days is too high compared to work in progress of only
3days. This suggests that the raw material are being held more than
necessary. A just in time inventory system should be adopted.
3. Trade payables payment delay: as average trade payable payment
period is 30 days, its lower than average supplier credit terms of 35
days. Paying the supplier earlier than credit term is detrimental to cash
cycle. Paying on 35 days will improve the cash operating cycle by 5
days.

(d) Discuss the motives for a business to hold cash.

transaction motive: holding cash for day to day transactions of a

company is called transaction motive. Paying suppliers according to
agreed terms and paying wages to employees are examples of such
transactions. Failure to make such payments at timely basis will disrupt
the business severely.

precautionary motive: holding cash to be able to meet unexpected cost

is precautionary motive of holding cash. Unexpected fine or legal claims
are example of such costs. inability to pay them may harm the reputation
of the company or may even lead to closing up the business.

speculative motive: holding cash so that investment opportunities can

be taken is called speculative motive. Unexpected opportunities may arise
any time. Holding some cash will increase the chances to take advantage
of such opportunity such as acquiring undervalued company.

Pumice

(b) discuss the ways in which implementing the proposed

changes in working capital represent:

(i) changes in working capital investment policy of pumice co

Working capital investment policy considers the level of current assets
used to support the revenue generated compared to a different company.

If a company has lower level of current asset to support the similer level
of revenue compared to another company, it has an aggressive
investment policy in relation to the other company. And the other
company has a conservative investment policy in relation to the first one.

#### compare REVENUE/CURRENT ASSET RATIO or REVENUE/NET

WCAP RATIO from the scenario if no other company to compare
with ####

As there is no other company to compare with, the effect of implementing

the proposed changes can be measured by comparing revenue/current
asset ratio. As it has only changed from ...… to …., no significant change
in working capital level has occurred.

The revenue/net working capital has changed from …. To …. Suggesting a

change in working capital.

(ii) changes in working capital funding policy of pumice co

Working capital funding policy considers if long term or short term finance
has been used for working capital.

If a company uses long term source of finance to fund its permanent and
a portion of fluctuating current asset, then it has an conservative working
capital funding policy. If it uses a short term finance to fund its fluctuating
current assets and a portion of permanent current asset, has an
aggressive funding policy. A matched policy is where long term finance is
used for permanent current asset and short term finance is used for
fluctuating current asset.

Conservative funding policy is less risker as long term loans are less
riskier than short term. But long term loans are more expensive than short
term. So it decreases profitability.

#### compare “short/long term liability in relation to current

asset” from scenario ####

As …% of current assets were funded by long term finance and after

expansion …% current asset will be funded by long term finance, the
company shifting to….
Oscer

(b) Discuss reasons why company may benefit from factoring

Free up management time: factoring can free up management and allow

them to focus on important things.

Economies of specialisation: as factors specialise on receivable

management, they can offer ‘economies of specialization’ they are expert
at getting the customer pay quickly and reduce bad debts to such level
that companies are not able to.

Scale economies: as the scale of factors operation is large, they can do

this more cheaply than the clients. Factors fee can be less then clients
administration cost.

Bad debt insurance: insurance against bad debt protects clients from non
payments. Although it has a cost but small companies who can not handle
the shock of a large bad debt, can protect themselves by factoring.

Finance source: if the company has exhausted its other financing sources,
factoring can be useful to them.

(c) Discuss three factors which determine the level of a

companies investment in working capital

The nature of the industry and its working capital cycle length:

Some businesses have longer production process which results in a longer

working capital cycle. For example, construction companies take a longer
to generate cash after investing on it. On the other hand, supermarkets
almost doesn’t have any credit sales which may lead to a zero or negative
working capital cycle.

Working capital investment policy:

If the company has an aggressive policy it will grant shorter credit period
to customers and take longer time to pay the suppliers. This will help
them achieve short term finance. If the company has a conservative
working capital investment policy they take will offer long credit period to
promote sales and take less time to pay suppliers.

Efficiency of management and term of trade:

If the management of working capital if inefficient, the working capital

may require more investment. If the credit control is weak then the
company will have high level of average receivables. If the production is
not managed efficiently then inventory costs such as holding, ordering
and purchasing cost will be high.

Dusty

(b) discuss key factors in determining working capital funding

policy

Permanent and fluctuating assets:

Permanent current assets represent the minimum level of current asset

needed to run the business. The portion of current assets that is subject
to variation in business activity is fluctuating current asset.

Relative cost of short term and long term finance:

Long term finance is costlier than short term finance. But long term
finance are less risky than short term finance.

Matching principle:

The matching principle states that maturity of asstes should match the
maturity of the finanace that is used to support them. This means
permament current assets should be finanaced from long term source and
fluctuating current asset should be financed from short term source.

Different funding policy and their relative costs:

A matching funding policy will finance permant current asset from long
term and fluctuating current asset from short term source. A conservative
funding policy will finance permanent current asset and a portion of
fluctuating current asset from long term source and the balance from
short term source. Aggressive funding policy….

A conservative policy is less risky but also less profitable. An aggressive

policy is more risky but more profitable. A matching policy balances the
risk and the profitability.

Managements attitude towards risk:

Nused
(c) discuss how company can improve management of
receivables.

Credit analysis:

Risk of bad debt can be minimised by credit analysis. Credit analysis is

assessing the credit worthiness of new customers. Existing customers
credit should worthiness should also be reviewed regularly.

Credit control:

Customers who have been granted credit should be monitored regularly

to ensure that they are following the agreed credit term. Credit control
can be done by analysing aged receivables list.

Collection of debt:

Customers with credit should be informed regularly about their accounts.

Amounts about to be due and amount outstanding and the term that have
been given to them. Invoice should be raised promptly after sale and
regular statements should be sent.

Factoring:

Factoring means outsourcing the management of trade receivables.

Factoring companies offer expertise and specialist knowledge for credit
analysis, credit control and debt collection. They can also provide an
advance which can be used as a source of finance.

Flit

(e) discuss two ways a company can reduce risk associated to

foreign account receivables.

Letter of credit and bankers acceptance

Forfeiting

Export factoring

Export credit insurance

Using bills of exchange.