Required

(a) Using profitability, debt, and shareholders’ investment ratios, discuss the performance of ABC Co
over the last two years.
(b) Explain why accounting profits may not be the best measure of a company’s achievements.

Pretech has carried on business for a number of years as a retailer of a wide variety of consumer
products and it operates from a number of stores. In recent years the entity has found it necessary to
provide credit facilities to its customers in order to maintain growth in revenue. As a result of this decision
the liability to its bankers has increased substantially. Extracts from the financial statements for the year
are provided below.
Other information
Depreciation charged for the three years in question was as follows.


The other interest bearing borrowings are secured by a floating charge over the assets of Phoenix.
Their repayment is due on 30 June 20Y9.
The bank loans are unsecured. The maximum lending facility the bank will provide is $630m.
Over the past three years the level of credit sales has been:

The entity offers extended credit terms for certain products to maintain market share in a highly
competitive environment. Given the steady increase in the level of bank loans which has taken place
in recent years, the entity has recently written to its bankers to request an increase in the lending
facility. The bank is concerned at the steep escalation in the level of the loans and has requested an
urgent meeting.
Required
(a) Using suitable ratios, analyse the information provided and recommend what action should be
taken.
(b) Explain what is meant by the ‘risk/return trade-off’ and its relevance to the bank in assessing the
request for further loan finance.

You are an accounting technician working at Exclusive Inc, a company that manufactures and
distributes
clothing. You have estimated the following figures for the coming year:
Sales $5,600,000
Average receivables $506,000
Gross profit margin 25% on sales
Average inventories
Finished goods $350,000
Work in progress $550,000
Raw materials $220,000
Average payables $210,000
Material costs represent 50% of the total cost of sales.
Exclusive Inc imports most of its materials from overseas countries, especially Pernisia. The high
inflation rates in Pernisia have meant that the company's cost of materials has risen rapidly over
recent years. This has led to a significant deterioration in the company's margins, which, coupled with
its increasing liquidity problems, is making the shareholders nervous.
Required
(a) Calculate the cash operating cycle, to the nearest day.
(b) Suggest four methods of reducing the length of the cash operating cycle.
(c) Discuss:
(i) The significance of trade payables in a firm's working capital cycle; and
(ii) The dangers of over-reliance on trade credit as a source of finance.
d) Identify and explain the key elements of a receivables management system

Discuss the factors to be considered when planning ways to invest any surplus cash
Discuss the advantages and disadvantages of using overdraft finance to fund any cash shortages
Explain how the Baumol model can be employed to reduce the costs of cash management.

Velm Co sells stationery and office supplies on a wholesale basis and has an annual turnover of
$4,000,000. The company employs four people in its sales ledger and credit control department at an
annual salary of $12,000 each.
All sales are on 40 days' credit with no discount for early payment. Bad debts represent 3% of turnover
and Velm Co pays annual interest of 9% on its overdraft. The most recent accounts of the company
offer the following financial information:

Velm Co is considering offering a discount of 1% to customers paying within 14 days, which it believes
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 period taken by its customers to 26 days. The consequent
reduction in the time spent chasing customers where payments are overdue will allow one member of
the credit control team to take early retirement.
Two-thirds of customers are expected to take advantage of the discount.
Required
(a) Using the information provided, determine whether a discount for early payment of 1 per cent will
lead to an increase in profitability for Velm Co.
(b) Discuss the relative merits of short-term and long-term debt sources for the financing of working
capital.
(c) Discuss the different policies that may be adopted by a company towards the financing of working
capital needs and indicate which policy has been adopted by Velm Co.
(d) Outline the advantages to a company of taking steps to improve its working capital management,
giving examples of steps that might be taken.

Special Gift Suppliers Co is a wholesale distributor of a variety of imported goods to a range of retail
outlets. The company specialises in supplying ornaments, small works of art, high value furnishing
(rugs, etc) and other items that the chief buyer for the company feels would have a market. In seeking
to improve working capital management, the financial controller has gathered the following
information.
Months
Average period for which items are held in inventory 3.5
Average receivables collection period 2.5
Average payables payment period 2.0
Required
(a) Calculate Special Gift Suppliers' funding requirement for working capital measured in terms of
months.

In looking to reduce the working capital funding requirement, the financial controller of Special Gift
Suppliers is considering factoring credit sales. The company's annual turnover is $2.5m of which 90%
are credit sales. Bad debts are typically 3% of credit sales. The offer from the factor is conditional on
the following.
(1) The factor will take over the sales ledger of Special Gift Suppliers completely.
(2) 80% of the value of credit sales will be advanced immediately (as soon as sales are made to the
customer) to Special Gift Suppliers, the remaining 20% will be paid to the company one month later.
The factor charges 15% per annum on credit sales for advancing funds in the manner suggested. The
factor is normally able to reduce the receivables' collection period to one month.
(3) The factor offers a 'no recourse' facility whereby they take on the responsibility for dealing with bad
debts. The factor is normally able to reduce bad debts to 2% of credit sales.
(4) A charge for factoring services of 4% of credit sales will be made.
(5) A one-off payment of $25,000 is payable to the factor.
The salary of the Sales Ledger Administrator ($12,500) would be saved under the proposals and
overhead costs of the credit control department, amounting to $2,000 per annum, would have to be
reallocated. Special Gift Suppliers' cost of overdraft finance is 12% per annum. Special Gift Suppliers
pays its sales force on a commission only basis. The cost of this is 5% of credit sales and is payable
immediately the sales are made. There is no intention to alter this arrangement under the factoring
proposals.
Required
(b) Evaluate the proposal to factor the sales ledger by comparing Special Gift Suppliers' existing
receivable collection costs with those that would result from using the factor (assuming that the factor
can reduce the receivables collection period to one month).
(c) As an adviser to Special Gift Suppliers Co, explain:
(i) How a credit control department might function
(ii) The benefits of factoring
(iii) How the financing of working capital can be arranged in terms of short and long term sources of
Finance. In particular, make reference to:
(1) The financing of working capital or net current assets when short term sources of finance are
exhausted
(2) The distinction between fluctuating and permanent current assets.