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 unitMaterial cost Rs. 40 per unitLabour cost Rs. 20 per unitOverheads 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 Quantityb). Re-order LevelAssume 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 unitCompany 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 000The 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. 650000Percentage of net profit on cost of sales 25% Average credit allowed to customers 10 weeksAverage credit allowed by suppliers 4 weeksAverage stock (for sales requirements) 8 weeksAdd 10% to computed figure for contingencies.Average stock required for sale

650 000 × 8/52 × 75/100650 000 × 0.154 × 0.7573 000 × 1.10 of contingencies82 500Average credit allowed to customers ( i.e. sundry debtors)

650 000 × 10/52 × 75/100650 000 × 0.192 × 0.7593 600 × 1.10 of contingencies103 000Total current Assets 185 000Less creditors650 000 × 4/52 × 75/100650 000 × 0.07692 × 0.7537 498 × 1.10 of contingencies41 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 2600 tons

Stock of raw materials 3 weeks

Processing period 2 weeks

Stock of finished goods 5 weeks

Credit period to customers 8 weeks

Credit allowed by the suppliers 5 weeks

Price of raw material 80% of sales

Wages and overheads 25% of sales

Selling price Rs. 200 per ton

Cash balance needed Rs. 30000

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

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. Rs.

1-4-04 31-3-05

Stock of raw material 35000 55000

Stock of work in progress 10000 30000

Stock of finished goods 30000 10000

Sundry debtors 50000 50000

Purchase of materials --- 200000

Wages and manufacturing expenses --- 80000

Administrative & selling expenses --- 40000

Sales --- 500000

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

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.

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 Rs 100 000Less bad debt @ 2 % of 100 000 2 000Less collection charges @ 2% of 100 000 2 000

Investments in additional sales 100 000 × 15/360 × 5/100 208

Additional profit Rs 96 79212% 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 Rs 300 000Less bad debt @ 4% of 300 000 Rs 12 000Less collection charges@ 5% 300 000 Rs 15 000

Investment in additional sales= 300 000×30/360 25 000Additional profit 218 00012% interest rate on investment 29 760Net additional profit 218 240

Percentage contribution on additional sales = 218 240/ 300 000 = 72.75%

c) Credit policy number 3

Contribution on additional sales Rs 700 000Less bad debts @ 10% of 700 000 70 000Less collection charges @ 10% of 700 000 70 000

Investment in additional sales 700 000 x 60/360 116 66712% interest rate on investment 53 200

Net additional profit 390 133 Ratio of cross profit to contribution on additional sales

= 390 133 / 700 000= 55.73= 55.7 %

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 long-

term 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 firm’s 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 C’s 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