Working Capital Management !

At the moment, receivables are 550,000. If we give the discount then receivables will be 26/365 x $4M (This comes to 285,000, not 283,000, but without seeing the whole question I cannot really say more.)

Ok Dear Tutor, I will write full question. Vell com sells stationary and office supplies on wholesaleable basis and has annual turnover 4 mln. The company employs four people in it's sales ledger and credit control department at annual salary $12000 each. Alll sales are on 40 days credit with no discount for early payment. Bad debts reprsents 3% of turnover and Velm com pays annual interest of 9% on it's overdraft. The most recent accounts of company financial information. Non current asset -17500 inventory - 900 Recievable - 550 Cash - 120 Ordinary shares - 3500 Reserves - 11640 12% Bonds - 2400 Trade payable - 330 Overdraft- 1200 Velm Co is considering offering discount of 1% to customers paying within 14days which it believs will reduce bad debts to 2.4% of turnover. The company also expects that offering a discount for early payment will reduce the average credit taken by it's customers to 26 days. The consequent reduction in time spent chasing customers where payments are overdue will allow one member of credit control team to take ealry retirement. Two thirds of customer are expected to take advantage of the discount. Question> Using the information provided above determine whether a discount for early payment of 1% percent will lead to an increase in profitability for Velm comp.? Thanks in advance

Since 2/3 of the customers take a 1% discount, the discount is 2/3 x 1% x $4M = 26,667 Since the new receivables period is 26 days, the new average receivables will be 26/365 x ($4M - 26,667) = 283,032. I think this is what you were querying. If anything else in the answer does not make sense then ask! (The examiner did say after this question that you would still get full marks is you calculated the new receivables as 26/365 x $4M (i.e. if you ignored the discount when calculating the new receivables))

Dear Tutor, One thing I could not understand why you did minuse $26,667 from receivables balance ?

As i know theoritically how to calculate receivable balance if the discount is offered is as like below: Receivable balance: 4000x2/3x14/365 + 4000x1/3x40/365=102.3+146.1=248.4 But the correct answer is 283000

There is nothing theoretical involved! The question actually says what the average receivables days will be: 26 days. Also, just because that sales are on 40 days credit, does not mean that people actually pay in 40 days (in fact, if you calculate the current receivables days, it is more that 40 days). Also, even if they did currently pay in 40 days, why should those who take the discount continue to pay in 40 days? If the question tells you the average receivables days, then there is no point in making extra work :-)

Yeah, Thanks so much Dear Tutor, I was also wondering when I calculated average receivable days based on receivable on balans sheet 550/4mlnx365= 50 days but i was wondering why it is different from 40 days as question says. Thanks so much Dear Tutor, your explanation is so clear for me now.

You are welcome :-)

Dear Tutor, I have another question The current policy is order 100,000 units when the inventory levels falls to 35000 units.Forecast demand to meet production requirement during the next year is 625000 units. The cost of placing and processing an order is $250 while the cost of holding a unit in stores is $0.5 per unit per year. Both costs are expected to be constant during the next year. Orders are recieved two weeks after being placed with suppliers. You should assume a 50 week year and that demand is constant throughout the year. Calculate the cost of the current ordering policy and determine the saving that could be made by using the EOQ model. My calculation method. D=625000 Co=250 Ch=0.5 EOQ= 25000 Total cost= 625000/25000x250+25000/2x0,5= 12500 Total cost (By company policy)= 625000/100000x250+100 000/2x0.5=26563 Saving= 26563-12500=14063 _____________________________________________________________________ Calculation by book Minimum inventory level= reorder level -(average usagexaverage lead time) Avergae usage per week= 625000/50=12500 Avergae lead time= 2 weeks Reorder level=35000 units Minimum inventory level=35000-(12500x2)=10 000 units Average inventory = Minimum level+reorder level/2 = 10000+(100 000/2)=60 000 units Annual holding cost=60 000 x0.5 = 30 000 Annual order cost= 250x(625000/100 000) = 1563 Annual cost= 30000+1563=31563 EOQ=25000 Number of orders per years=625000/25000=25 Annual oredering cost=250x25=6250 Annual holding cost =(10 000+(25000/2))x0.50 =11250 Annual total cost =11250+6250=17500 Saving as a result of EOQ= 31563-17500=14063 So, you can see both method are the same result. What do you think My method is correct if I follow. Because the book method is so complex. Thanks in advance

If the question only asked for the saving, then what you have done is fine. However, it also asked for the cost of the current ordering policy. Here there is an extra holding cost because they are ordering sooner than they need to and so there is extra inventory held throughout the year. They are ordering when they still have 35,000 left in inventory. While waiting for the new order to arrive they will sell 2/50 x 625000 = 25,000 units. This means that they will have 10,000 more units than they need, throughout the year. The cost of holding these extra 10,000 units is 10,000 x $0.5 = $5,000. This explains why your answer for the cost of the current ordering policy is $5,000 different. (The saving is not affected, because the $5,000 a year will be payable whether they keep to the current policy or change to the EOQ)

thanks Tutor !

You are welcome :-)

Hi Good evening Tutor, I have one more question which I calculated the correct answer but slightly confused with method of book. I give full question detail. Income statement: Sales: 21,300 Cost of sales: 16,400 Gross profit: 4900 Balance sheet: Receivables; 3500 Overdraft; 3000 A factor has offered to manage the trade recievables of Bold in a servicing and factor financing agreement. The factor expects to reduce the average trade recievables of Bold from current level to 35 days to reduce bad debts from 0.9% of turnover to 0.6% of turnover. and save Bold 40 000 per year in admin cost. The factor would also makae an advance to Bold 80% of the revided book value of recievables. The interest rate on the advance would be 2% higher than the 7% that Bold currently pays on its overdraft. The factor would charge a fee of 0.75 % of turnover an a with- recourse basis or a fee of 1.25 % of turnover on a recourse basis. Assume 365 days in a year. that all sales and supplies on a credit. Question: Calculate the value of Factor's offer 1) On a with recourse basis 2) on a with non-recourse basis. _______________________________________________________________________ My calculations method; Let us consider the costs with out factors offers. Bad debts=21300x0.9=191.7 Financing cost= 3500x7%=245 Admind cost= 40 Total cost=191.7+245+40=476.7 1) what will be total costs If Factors offer with recourse basis Factos cost= 21300x0,75%=159.75 Finance cost ( for 80% advance)= 35/365x21300x80%x9%= 147 FInance cost (for 20 remaing receivables)= 35/365x21300x20%x7%= 28.6 Bad debts = 21300x 0.6%= 127.8 Total cost= 159.75+147+28.6+127.8= 463,15 Net Benefit from Factor service on Recourse basis= 476.7-463.15=13.55 ( Answer is correct with the book) 2) What will be the total cost if factors with non recourse basis; Factor cost= 21300x1.25%=266.25 Finance cost ( for 80% advance)= 35/365x21300x80%x9%= 147 FInance cost (for 20 remaing receivables)= 35/365x21300x20%x7%= 28.6 Total costs= 266.25+147+28.6= 441,85 Net Benefits from Factors with non recourse basis= 476.7- 441,85= 34.85 ( correct answer with the book) BUT WHAT I AM CONFUSED HERE AS I KNOW NON RECOURSE BASIS FACTOR SERVICE IT TAKES ALL THE BAD DEBTS. IF I TAKE THE BAD DEBTS FOR NON RECOURSE IT IS WRONG ANSWER COMES. look my method i calculated is there any wrong ?

I am puzzled because you say that your answer is correct with the book, and that is fine! Nor-recourse factoring is where the factor bears all the irrecoverable debts, and therefore the company has no irrecoverable debts.