Working Capital Management

ASSIGNMENT A (FIVE ANALYTICAL QUESTIONS)

Q1. Find out working capital by operating cycle method, taking 360 days in a year:Sales 8000 units Rs. 120 per unit Material cost Rs. 40 per unit Labour cost Rs. 20 per unit Overheads Rs. 30 per unit Customers are given 45 days credit and 50 days credit is taken from suppliers. Raw materials for 30 days and finished goods for 25 days are kept in stock. Production cycle is of 20 days. Production cycle = 70 days; Total operation cost = Rs. 720000, Working capital required = Rs. 140000. Q2. A company has an expected usage of 50000 units of a commodity during the coming year. The cost of placing an order is Rs. 100 and carrying cost per unit is Rs. 2.50, Lead time of an order is 5 days and company will keep a reserve of two days usage. You are required to calculate:a). Economic Order Quantity b). Re-order Level Assume 250 working days in a year. EOQ = 2000 units, Re-order Level = 1400 units. Q3. After inviting tenders, two quotations are received as follows:(a) Rs. 1.20 per unit; (b) Rs. 1.10 per unit plus Rs. 3000 fixed charges to be added irrespective units ordered. Advice with your argument, to whom order should be placed and for what quantity?
Company A= Rs. 1.20 per unit Company B = Rs. 1.10 per unit + fixed Rs. 3000 When buying 30 000 units Company A= Rs. 1.20 30 000 = Rs. 36 000

Company B = Rs. 1.10 30 000= Rs. 33 000 + Rs. 3000 = Rs. 36 000 The firm can buy from either A or B ; But if it orders more than 30 000 units it would be cost effective to order from company B but for units that are R36 000 and less it would be advisable to order from company A.

Q4. From the information given below, calculate the working capital requirements:Budgeted sales Rs. 650000 Percentage of net profit on cost of sales 25% Average credit allowed to customers 10 weeks Average credit allowed by suppliers 4 weeks Average stock (for sales requirements) 8 weeks Add 10% to computed figure for contingencies. Average stock required for sale 650 000 8/52 75/100 650 000 0.154 0.75 73 000 1.10 of contingencies 82 500 Average credit allowed to customers ( i.e. sundry debtors) 650 000 10/52 75/100 650 000 0.192 0.75 93 600 1.10 of contingencies 103 000 Total current Assets 185 000 Less creditors 650 000 4/52 75/100 650 000 0.07692 0.75 37 498 1.10 of contingencies 41 248 Working Capital Required = 185 000 41 248 = 143 752 = 144 000 Working capital required = Rs. 144000.

Q5:- Calculate the estimate of working capital required by an organization:Expected annual production Stock of raw materials Processing period Stock of finished goods Credit period to customers Credit allowed by the suppliers Price of raw material Wages and overheads Selling price Cash balance needed
Working Capital required Stock of raw material = ( 2 600 200 80/100 5/52) = 2 600 200 0.8 0.05769 = Rs 24 000 Stock of work in progress = (2 600 200 75/100 2/52) = 2 600 200 0.75 0.03846 = 14 999.40 = 15 000 Stock of finished goods = ( 2 600 200 105/100 5/52) = 2 600 200 1.05 0.09615 =52 497.90 =52 500 Sundry debtors = ( 2 600 200 105/100 8/52) = 2 600 200 1.05 0.15382 =84 000 Cash Balance = Rs 30 000 Total Current Assets = 205 500

2600 tons 3 weeks 2 weeks 5 weeks 8 weeks 5 weeks 80% of sales 25% of sales Rs. 200 per ton Rs. 30000

Less Creditors = ( 2 600 200 80/100 5/52) = 2 600 200 0.8 0.09615 = 39 998.40 = 40 000 Required working capital = 205 500 40 000 = 165 500

ASSIGNMENT B - THREE ANALYTICAL QUESTIONS + 1 CASE STUDY )

Q1. From the following figures calculate the period of operating cycle and estimate the amount of working capital required:Rs. 1.4.4 Stock of raw material Stock of work in progress Stock of finished goods Sundry debtors Purchase of materials Wages and manufacturing expenses Administrative & selling expenses Sales Assume 360 days in a year. Operating cycle period = 120 days, Cost of goods sold = Rs. 300000, Working capital required = Rs. 100000. Q2:- B Limited gives the following information about its liquidity. Interest on securities 14.4% per annum Fixed cash on sale of securities Rs. 900. 35000 10000 30000 50000 --------Rs. 31-3-05 55000 30000 10000 50000 200000 80000 40000 500000

The company obtains credit of 60 days from its creditors. All the sales is on credit.

Standard deviation of change of daily cash balance Rs. 4000. Management wants to maintain a minimum cash balance of Rs. 10000. Calculate Return Point and Upper control level according to Miller Orr-Model. Assume 360 days in a year. Return Point = Rs. 40000, Upper control level = Rs. 100000. Q3. Annual sales of Modern company is 16000 units @ Rs. 50 per unit. Its variable cost is Rs. 30 per unit and fixed cost Rs. 160000 per year. The company is considering to relax its credit policy. This will increase its sales by 20% and average collection period will increase from 30 days to 45 days. Bad debts are expected at 3% on increase in sales and collection charges will increase by Rs. 20000. If required rate of return on investments is 15% after tax and rate of tax is 40%. Will it be fair to relax the credit policy Return required = Rs. 5800; the credit policy can be relaxed based on the current return

CASE STUDY Ques. A company wants to fix its credit policy. It is considering on three alternatives as under:1. sale on 15 days credit at 5% cash discount, or 2. sale on 1 month credit without cash discount, or 3. sale on 2 months credit without cash discount In (1) above additional sales would be Rs. 100000; in (2) Rs. 300000 and in (3) Rs. 700000.

Collection charges will be in (1) 2%, (2) 5% and (3) 10% of sales. Bad debts are expected at 2%, 4%, and 10% respectively. Assuming interest on investment @ 12% per annum, state which policy should be adopted. Below is an analysis of the policies;
a) Credit policy number 1 Contribution on additional sales Less bad debt @ 2 % of 100 000 Less collection charges @ 2% of 100 000 Investments in additional sales 100 000 15/360 5/100 Rs 100 000 2 000 2 000 208

Additional profit Rs 96 792 12% interest rate of investment(12% of 15792) RS 11 495 Net profit Rs 84 297

Percentage contribution on additional sales 84 297/100 000 =84.29% b) Credit policy number 2 Contribution on additional sales Less bad debt @ 4% of 300 000 Less collection charges@ 5% 300 000 Investment in additional sales= 300 00030/360 Additional profit 12% interest rate on investment Net additional profit Rs 300 000 Rs 12 000 Rs 15 000 25 000 218 000 29 760 218 240

Percentage contribution on additional sales = 218 240/ 300 000 = 72.75% c) Credit policy number 3 Contribution on additional sales Less bad debts @ 10% of 700 000 Less collection charges @ 10% of 700 000 Rs 700 000 70 000 70 000

Investment in additional sales 700 000 x 60/360 12% interest rate on investment Net additional profit Ratio of cross profit to contribution on additional sales = 390 133 / 700 000 = 55.73 = 55.7 %

116 667 53 200 390 133

Based on the above calculations, it will be advisable to adopt policy one because it has better returns

ASSIGNMENT C (MULTIPLE CHOICE OBJECTIVE QUESTIONS)

MULTIPLE CHOICE QUESTIONS 1. The results of overtrading may be a. Overcapitalization b. Illiquidity c. Technical insolvency d. Both b and c above 2. Which of the following is/are true? a. A company following an aggressive working capital policy will finance its current assets more from long term sources. b. A company following of conservative working capital policy will finance its current assets more from long term sources.

c. A company having a conservative working capital policy will have a higher current ratio than one following an aggressive working capital policy. d. Both b and c above 3. Which of the following is/are true in respect of working capital? a. Gross working capital is the sum of the total current assets. b. Net working capital represents the margin on working capital supported by longterm funds. c. Net working capital can be negative. d. all of a, b, and c above 4. Under trading means a. Having low amount of working capital b. High turnover of working capital c. Sales are less compared to assets employed d. Assets are less compared to sales generated 5. Working capital gap is a. Equal to current assets plus current liabilities including bank borrowings b. Equal to current assets less current liabilities including bank borrowings c. Equal to current assets less current liabilities excluding bank borrowings d. Equal to current assets plus current liabilities other than bank borrowings 6. Working capital margin is a. The difference between current assets and current liabilities b. The increase in working capital requirement as a result of increased production

c. The portion of working capital requirement that will be finance through banks loans d. The portion of working capital which will be financed through long term sources. 7. Overtrading implies a. A disproportionately high investment in current assets compared to the value of sales. b. Greater sales generated by smaller investment in current assets c. A high turnover of current assets in proportion to sales d. High turnover of working capital 8. The average collection period is determined by a. Daily credit sales divided by average balance in receivable account b. Balance in receivable account by average daily credit sales c. Total credit sales divided by average balance in receivable account d. None of the above 9. Which of the following is not factor that affect the composition of the working capital? a. Nature of business b. Nature of raw material in used c. Tax structure of the company d. Process technology used 10. Which of the following is / are criterion /criteria for evaluation fo working capital management?

a. Liquidity b. Inventory turnover c. Availability of cash d. All of the above 11. Current assets are characterized by a. Short life span b. Long life span c. Quick transformation into other forms of assets d. Both a and c above 12. Which of the following factors does not influence the composition of working capital? a. Nature of business b. Nature of raw materials used c. Nature of finished goods d. Financial leverage of the firm 13. If the net working is negative then it indicates that a. Long term funds have been used for financing short term assets b. Long term funds have been used for financing long term assets c. Short term funds have been used for financing long term assets d. Short term funds have been used for financing short term assets 14. Which of the following will not be considered as a current assets? a. Sundry debtors b. Cash

c. Marketable securities d. Goodwill 15. Which of the following measures should be taken to overcome under trading? a. Increasing the debt equity ratio b. Decreasing the debt equity ratio c. Hastening the collection process d. Slowing down the collection process 16. Which of the following factors have bearing on working capital management? a. Import duties on capital goods b. Manufacturing cycle c. Continuity in the supply of raw materials d. Both b and c above 17. Two important issues in formulating working capital policy are a. Nature of business and operating cycle b. Trade credit and permissible bank finance c. The ratios of current assets to sales and short term financing to long term financing d. The level of current ratio and quick ratio 18. The profit criterion for working capital a. Is relevant in analyzing working capital decisions b. Is compulsory for analyzing working capital decisions c. May be substituted with the Net Present Value criterion in analyzing working capital decisions

d. May be substituted with PVIFA concept of analyzing working capital decisions 19. If the net working capital negative, it signifies a. The current ratio is less than I b. Long term uses are met out of short term sources c. The liquidity position is not comfortable d. All of the above 20. A current ratio less than one implies a. Negative net working capital b. Financing of working capital using long term sources c. Adoption of conservative working capital policy d. A low debt service coverage ratio 21. The criterion of profit per period is equivalent to the criterion of net present value in the case a. Current assets form a small fraction of total assets b. Investment in current assets is reversible c. The value of current assets is higher than the value of current liabilities d. Part of current assets are financed from long term sources 22. Net operating cycle period is a. Equal to the accounting period of the company b. The period from raw material procurement to sale of finished goods. c. The length of time taken for a rupee invested in current assets to come back with profit to the company d. The time between payment of raw material purchases and the collection of cash for sales

23. Operating cycle can be shortened by increasing a. Manufacturing time b. Duration of credit availed c. Credit period to the customers d. Stock held in stores 24. Which of the following is true with respect to net working capital? a. It is the total of current assets b. It is necessarily financed by short term funds c. It is the difference between current assets and spontaneous current liabilities. d. Negative net working capital implies long term funds utilized for short term purposes. 25. Which of the following factors influences the choice of liquidity mixed to be maintained by a company? a. Nature of control with the managers b. Extent of leverage c. Marginal cost of capital d. Uncertainty in cash flows 26. Which of the following factors influences the composition of working capital? a. Nature of business b. seasonality of operations c. marketability of finished goods d. All of the above

27. Which of the following is not a motive for holding cash:a. Transaction purposes b. Precaution against unexpected expenses c. Extending loans to group companies d. speculation purposes 28. Which of the following is not the motive for the companies to hold cash? a. Transaction motive b. Precautionary motive c. Speculative motive d. Capital investments 29. Cheques that have been deposited may not be immediately available for use due to a. collection float b. payment float c. Net float d. Deposit float 30. Float denotes the a. Difference between bank balance and the balance shown in the firms books b. An instrument expedite cash inflows c. difference between cash inflows and outflows d. both a and b 31. Which of the following is not used for credit evaluation:a. Ratio analysis b. Bank references

c. Past experiences with the customers d. None of the above 32. Which of the following is not a cost of marinating receivables:a. Administrative costs b. Collection costs c. Defaulting costs d. Marketing costs 33. Which of the following is not the Cs for judgeing credit worthiness of a customer a. Collateral b. Capacity c. Credibility d. Character 34. Which of the following is not a measure for monitoring receivable a. Collection matrix b. ABC system c. Days sales outstanding d. Ageing scheduled 35. Which of the following is not a credit policy variable or a non financial company? a. over draft limit b. Credit standard c. Collection program

d. Cash discount 36. If the material is priced at the value that is realizable at the time of issue such pricing method is referred to as a. Standard price method b. Replacement method c. LIFO methods d. Weighted average cost methods 37. Which of the following is not a benefit of storing inventories:a. Avoidance of lost sales b. Availing of quantity discounts c. Reduction of order costs d. Reduction of carrying costs 38. Which of the following are sub-systems of inventory

management system? a. EOQ sub system b. Stock level sub system c. Reorder point sub system d. All of the above 39. Which of the following is not a method of pricing inventories? a. FIFO method b. LIFO method

c. Standard price method d. Shadow price method 40. C group items under ABC analysis are a. High value items b. High quantity items c. Low value items d. Both b and c