Question

The CFO of a company is proposing to boost his company’s return on net operating assets (RNOA) by paying suppliers later because the CFO claims ‘‘there’s no interest charged on accounts payable”. Using the concept of operating leverage, explain the CFO’s strategy, and discuss the factors that might cause the CFO’s strategy to succeed or fail.

Answer 1

In calculation of the operating cost, interest is avoided because it is not treated as operating cost but interest will ultimately be having a substantial role to play while determination of the profits, because interest will lower the overall profit of the company.

In using the concepts of the operating leverage, the company will be not taking interest calculation for payment but it will be taking all the other operating expenses related to its operations so that it is is not an appropriate reflection of the performance of the businesses and the chief financial officer should be trying to incorporate the impact of interest on the overall profits because if there are interest charged on the overall profits,then it would reflect the true position of the company's profitability.

In this case,chief financial officer is deliberately trying to avoid the payment of interest by lagging the payments in order to boost the overall return on net Operating Assets of the company, but it would be impacted in the overall profitability of the company because the interest will be payable to these creditors and they would be accounted in the overall profitability of the company so that will reduce the attractiveness of the company in the long run and this chief financial officers must be considering this from the prospective of overall profit rather than operational profit.

This can cause the chief financial officers to to succeed because it will lead to increase in the cash collection period but it will also be negatively impacted into the overall profitability of the company so it will be having the negative impact also.