Question

Table 1 provides projected financial statement values for Firm X (a firm that you work for as a treasury analyst). Calculate the change in operating cash flow that would result if management implemented the strategic and operational tactics needed to achieve the best in industry target values for the given operating working capital accounts. Discuss why operating cash flow would increase.

Table 1

	Firm X: Projected Value for Next Year	Best in Industry: Targets for Next Year
Accounts Receivable as a % of Revenues	15%	10%
Inventory as a % of Revenues	15%	10%
Accounts Payable as a % of Revenues	15%	20%
Revenues	$210M	$350M
Depreciation Expense	$15M	n/a
Net Income	$55M	$90M

Answer 1

Particulars	Projected for next year	Best in industry (Target)	Difference
Accounts receivable	15% of $210M = $31.5M	10% OF $350M = $35M	$35M-$31.5M = (-) $3.5M
Inventory	15% of $210M = $31.5M	10% OF $350M = $35M	$35M-$31.5M = (-) $3.5M
Accounts Payable	15% of $210M = $31.5M	20% OF $350M = $70M	$70M-$31.5M = (+) $38.5M

Thus, from the above calculation it can be seen that if the company wants to achieve target of next year, then it will occupy more accounts receivable and inventory resulting in a decreased cash flow, while accounts payable of the company will increase substantially from $31.5M to $70M. This means that net result of company’s cash flow will be positive.

Increase in cash flow (A/P) -               $38.5M

(-) decrease in cash flow(A/R) -          $3.5M

(-) decrease in cash flow(Inventory) -   $3.5M

Net increase/(decrease) in cash flow $31.5M

This increase in cash flow has occurred due to substantial increase of company’s accounts payable. The increase is driven by higher increase in accounts payable of the company and comparatively less increase in inventory and accounts receivable.