ABMF4024 Business Finance
Tutorial 8 Answer
23 December 2010
Question 1 The cash conversion cycle is the length of time funds are tied up in working capital, or the length of time between paying for working capital and collecting cash from the sale of the working capital. Holding other things constant, if you reduce the CCC you are reducing the amount of funds tied up. These funds have a cost; therefore, a reduction in funds will lower the firms costs and thus raise its profitability. Here we have made an assumption that you can reduce working capital without harming sales.
Question 2 When most of us use the term cash, we mean currency (paper money and coins) plus bank demand deposits. However, when corporate treasurers use the term, they often mean currency and demand deposits plus very safe, highly liquid marketable securities that can be sold quickly at a predictable price and thus be converted to bank deposits. Therefore, cash as reported on the balance sheets generally includes inclu des shortterm securities, which are also called cash equivalents.
Question 3 Tools 1)
Procedures
Use
a lockbox
1) Forecast cash inflows, outflow, and ending cash
2) Insist on wire transfer from customers 3) Synchronize inflows and outflows 4)
Use
a remote disbursement account
5) Reduce need for safety stock of cash i.
Increase forecast accuracy
ii. Hold marketable securities
balances 2)
Used
to plan loans needed or funds available to
invest 3) Can be daily, weekly or monthly forecast -
Monthly for actual planning and daily for actual cash management
iii. Negotiable a line of credit
Question 4 Goals
of inventory management
1) Reduce inventory cost 2) Make sure u have enough inventory for your company and customer needs Inventory Control System 1) Just-In-Time System 2) Computerized Inventory System 3) ABC System 4) Outsourcing
ABMF4024 Business Finance
Tutorial 8 Answer
23 December 2010
Question 5
Question 6 Sales = $15,000,000; Inventory = $2,000,000; A/R = $3,000,000; A/P = $1,000,000; CO on bank loan = 8%; CCC = ?
GS
= 0.8(Sales); 0.8(Sa les); Int In terest
CCC = Inventory conversion period + Average collection period Payables deferral period. Inventory Cost of goods sold per day $2,000,000 = [(0.8)($15,000,000)] /365
Inventory conversion period
=
=
$2,000,000 $32,876.7123
= 60.83 days. Average collection period =
=
Receivables Sales/365
$3,000,000 $15,000,000 / 365
= 73 days. Payables deferral period =
=
Payables Cost of goods sold/365
$1,000,000 $32,876.7123
= 30.42 days. CCC = 60.83 + 73 30.42 =
103.41 days.
2. Lower inventories and receivables by 10% 10% each and increase increase payables by 10%. Sales and CO GS remain the same. Inventory = $2,000,000 v 0.9 = $1,800,000. A/R = $3,000,000 v 0.9 = $2,700,000. A/P = $1,000,000 v 1.1 = $1,100,000. Calculate new CCC: Inventory conversion period
=
$1,800,000 $32,876.7123
= 54.75 days.
ABMF4024 Business Finance
Tutorial 8 Answer
Average collection period
=
23 December 2010
$2,700,000 $15,000,000 / 365
= 65.70 days. Payables deferral period
=
$1,100,000 $32, 76.7123
= 33.46 days. New CCC = 54.75 + 65.70 33.46 = 86.99 days
87
§
days.
Question 7 Annual sales RM50, 735,000 Inventory level RM15, 012,000 Account receivable balance outstanding RM10, 008,000 Payable deferral period 30days
Annual sales RM50,735,000 Inventory level RM13,066,000
After lowered inventory and a/c
Account receivable balance outstanding RM8,062,000
receivable by RM1,946,000
Payable deferral period 40days
New CCC Old CCC = 112 150 = -38days *Better because lower CCC, very fast to pay suppliers
ABMF4024 Business Finance
Tutorial 8 Answer
23 December 2010
Question 8 CCC
ICP
RCP
PDP
(shorten)
(shorten)
(shorten)
(longer)
Length of time receives
How
Time required to convert
Payment of cash
and makes payment when
convert good to sell it
receive cash inflow
long
you
take
to
receivable to cash *choose customers of 5 c i.
Character of customer
ii.
Capacity
iii.
Capital
iv.
Collect oral
v.
Condition of customer
In order to have shorter time frame CCC, RCP shorten, PDP longer, LCP shorten.
Question 9 The maturity matching, or self-liquidating, approach calls for matching asset and liability maturities. All of the fixed assets plus the permanent current assets are financed with long-term capital, but temporary current assets are financed with short-term debt. A more aggressive financing approach approa ch would involve financing some of its permanent assets with short-term short-term debt. The reason for adopting the aggressive policy policy is to take advantage of the fact that the yield curve is generally upward sloping, hence short-term interest rates are generally lower than long-term long-term rates. A more conservative financing approach would involve financing all permanent current assets as well as some of its seasonal seasonal needs with long-term capital. In this situation, the firm uses a small amount of short-term credit to meet its peak requirements, but it also meets a part of its seasonal needs by storing liquidity liqu idity in the form of marketable securities. This is a very safe, conservative financing policy. The aggressive approach is the riskiest of all three approaches because if the firm encountered temporary financial problems, the lender might not renew its loan. However, because the yield curve is normally upward sloping, short-term interest rates are lower than long-term rates, thus would lead to higher profits. The conservative approach app roach is the least risky but it is is also the least profitable of the three approaches. approach es. The maturity matching approach is between these two approaches in both risk and profitability. Optimistic and/or aggressive managers will probably lean more toward short-term credit to gain an interest cost advantage, while more conservative managers will lean toward long-term financing to avoid potential renewal problems.
