AACT 2173 Financial Management

Diploma in Accounting

CHAPTER 4 WORKING CAPITAL AND CASH MANAGEMENT

Important Formulas:

Ratio Formula
Current ratio Current Assets
¿
Current Liabilities
Quick ratio Current Assets−Inventory
¿
Current Liabilities
Inventory holding period Inventory
¿ x 365 days
Cost of goods sold
Finished goods holding period Finished goods
¿ x 365 days
Cost of goods sold
WIP holding period WIP
¿ x 365 days
Cost of goods sold x degree of completion
Raw materials holding period Raw material
¿ x 365 days
Annual purchases
Account receivable days Trade receivables
¿ x 365 days
Credit Sales
Account payables payment days Trade payables
¿ x 365 days
Credit purchases
Sales revenue/net working Salesrevenue
capital ratio
¿
Net Working Capital
Where net working capital = Current Asset – Current Liabilities
Cash operating cycle = Receivables collection period + Inventory holding period – payable payment period

Questions:
1. A business has an inventory turnover period of 46 days, receivables collection of 48 days
and payables payment period of 35 days. On average its working capital cycle is how many
days?

A. 33 days
B. 59 days
C. 48 days
D. 37 days

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AACT 2173 Financial Management
Diploma in Accounting

2. Given the following data:

Sales 250,000

Cost of goods sold 210,000

Purchases 140,000

Receivables 31,250

Payables 21,000

Inventory 92,500

Calculate the cash operating cycle.

Answer:
Receivables Collection Period = $31,250/ $250,000 x 365 days = 46 days
Inventory holding period = $92,500 / $210,000 x 365 days = 161 days
Payable payment period = $21,000 / $140,000 x 365 days = 55 days
Cash operating cycle = 46 days + 161 days – 55 days = 152 days

3. Light Co is a company specialising in the manufacture of a large range of light bulbs. Over
the last six months, the business has begun to expand, with an increase in sales of 20%
compared to the same six-month period last year. This expansion has given rise to a need
for increased working capital. The company has very little cash at present, and needs to
accurately ascertain its working capital requirements for the next year.

The following forecast figures are available.

Turnover for the year RM85,000,000
Costs as a percentage of sales:
Direct materials 20%
Direct labour 25%
Variable overheads 15%
Fixed overheads and selling and distribution costs 23%

The following average time periods are expected:

(i) Inventories
Raw materials are held in inventory for eight weeks and finished goods are held for
six weeks. All finished goods inventories and work-in-progress inventories include
direct materials, direct labour and variable overhead costs. Assume that goods
remain in work in progress for two weeks and are 75% complete as regards direct
materials and 50% complete as regards direct labour and variable overheads.
(ii) Accounts receivable
All customers are credit customers and take on average nine weeks to pay.
(iii) Accounts payable

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AACT 2173 Financial Management
Diploma in Accounting

The credit taken is four weeks for all expense categories.

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AACT 2173 Financial Management
Diploma in Accounting

Required:
Calculate the working capital requirement of Light Co for the next year. Assume that there
are 50 working weeks in the year. (to the nearest RM’000)

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AACT 2173 Financial Management
Diploma in Accounting

4. Brandy Co, a manufacturing company has provided information below. As an accountant of

the company, you are required to forecast their working capital requirements for the year
ahead.

Sales revenue RM22,000,000

Cost as percentage of sales revenue

Raw materials 30%
Direct labour 15%
Variable overhead 10%
Fixed overhead 10%
Other cost 5%

Working capital statistics

Average raw material holding period 4 weeks
Average work-in-progress holding period 3 weeks
Average finished goods holding period 4 weeks
Average trade receivables’ collection period 5 weeks

Average trade payables’ payment period

Raw materials 5 weeks
Direct labour 4 weeks
Variable overhead 3 weeks
Fixed overhead 2 weeks
Other costs 2 weeks

Other relevant information

i. All finished goods and work in progress values include raw materials, direct labour,
variable overheads and fixed overheads.
ii. Assume WIP is 70% complete as to materials, 60% complete as to direct labour, 50%
complete as to variable and fixed overheads.
iii. Assume there are 50 weeks in a year
iv. Assume that production and sales volume are the same.
v. All workings should be in RM’000, to the nearest RM’000.

Required:
Calculate the estimated working capital required by Brandy Co for the year, show all
necessary workings.

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AACT 2173 Financial Management
Diploma in Accounting

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AACT 2173 Financial Management
Diploma in Accounting

5. F Co is preparing its cash budgets for January, February and March. Budgeted information
is as follow:
Nov Dec Jan Feb Mar
Sales (units) 750 800 800 850 900
Production (units) 800 800 850 900 950
Direct labour and variable overheads incurred 48,000 48,000 51,00 54,000 56,000
(RM) 0
Fixed overheads incurred (including 20,000 20,000 20,00 20,000 20,000
depreciation) (RM) 0

The selling price per unit is RM200. The purchase price per kg of raw material is RM25. Each
unit of final product required 2kg of raw materials which are purchased on credit in the month
before they are used in production. Suppliers of raw materials are paid one month after
purchases.

All sales are on credit. 80% of the customers will pay one month after sales and the remainder
pay two months after sales.

The direct labour cost, variable overheads and fixed overheads are paid in the month which
they incurred.

Machinery costing RM100,000 will be delivered in February and paid for in March. Depreciation
on the new machinery will be RM10,000 per year.

Depreciation on fixed overheads per month is amounted to RM1,000.

The opening cash balance on 1 January is estimated to be RM15,000.

Required:

(a) Prepare a cash budget for each of the three months January, February and March.

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AACT 2173 Financial Management
Diploma in Accounting

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AACT 2173 Financial Management
Diploma in Accounting

6. Coolshades Co is a prosperous, private company whose five directors each own 20% of the
share capital. The company is involved in the distribution of a range of branded sunglasses
to various retail outlets. Since its foundation three years ago, the company has grown
rapidly. To date, the critical success factors have been the ability to offer a quality product at
a competitive price and to guarantee 24 hour delivery to customers.

To date, the company’s records have been maintained by a bookkeeper, with the auditors
preparing the half-yearly accounts for management review. The bookkeeper has recently
retired and you have been recruited as the accounting technician. The role has been
expanded to incorporate the preparation of monthly management accounts. Although
Coolshades Co is profitable, the company’s bank is increasingly concerned about the
current liquidity position and the management of working capital. Indications are that the
profitability of the company is being significantly eroded, despite the growth in sales. At a
recent meeting with the board of directors, you have been given a series of notes in order to
prepare a forecast cash flow for the next six months commencing 1 July 20X1.
 Notes:

a) Opening receivables are RM590,000 of which RM307,000 will be paid in July and the
remainder in August.
b) Sales are evenly spread for the six months which made a total of RM1,500,000.
c) 10% of sales revenue is for cash, the remainder are on credit. 4% of credit sales end up
as bad debts. 50% of customers pay in the month following sales and the remainder pay
in the subsequent month.
d) The gross profit percentage is 30%.
e) Purchases are obtained in the month prior to sale, and the related suppliers are paid in
the subsequent month and no purchases made in June.
f) Opening payables which will be paid in July are:
i. Trade payable                                                          RM210,000
ii. Distribution expense payables                                   RM35,000
g) Distribution expenses for this period will be RM33,000 per month, including RM7,000
depreciation. Distribution expenses are paid for in the month following the expense.
h) Administration expenses are a total of RM120,000, for the half year. This includes a
Christmas bonus of RM12,000, payable in December. All other expenses accrue evenly
over the period.
i) It is proposed that the company purchase new delivery vans from operating cash flows,
costing RM80,000, and directors’ cars costing RM100,000. Both would be purchased in
August and paid for in September.
j) Other payments are as follows:

i. Corporation tax for year ended 31.12.20X0   RM75,000 (due in September)

ii. Dividends for year ended 31.12.20X0            RM125,000 (due in August)

k) Inventory levels currently at RM825,000 are not expected to change.

l) Loan repayments totalling RM25,000 are quarterly in arrears (September and
December) and compromise RM20,000 principal and RM5,000 interest.
m) The company intends to undertake a market research project costing RM20,000 which is
to be paid in October. This project is to investigate the viability of setting up distribution
outlets in a neighbouring country.
n) Opening bank balance is RM200,000 overdrawn.

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AACT 2173 Financial Management
Diploma in Accounting

Required:
(a) Prepare a budgeted cash flow for EACH of the six months to 31 December 20X1, (all figures
to the nearest RM’000), stating clearly any assumptions you make. 

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AACT 2173 Financial Management
Diploma in Accounting

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