Question

Question 8: The following company has sales of $30 million and a cost of goods sold of $18 million. The balance sheet for period ending 31 December 2019 for this company appears below:

Assets                                                      $000	Liabilities and Shareholder Equity      $000
Cash                                                         2500	Accounts Payable                                    1600
Accounts Receivable                             4400	Other Payables                                           900
Inventory                                                1500	Accruals                                                      1100
Total Current Assets                            8400	Total Current Liabilities                          3600
Property Plant and Equipment         10500	Long Term Debt                                        2500
Total Assets                                         18900	Total Liabilities                                         6100
	Issued Equity                                           12800
	Total Liability & Shareholder Equity 18900

a. Calculate the company’s net working capital in 2019.                         

b. Calculate the company’s cash cycle for 2019.

c. The industry average for accounts receivable is 28 days. What would this company’s cash cycle have been in 2019 if it had matched this industry average for accounts receivable? Comment on this new cash cycle outcome against b. above.

Answer 1

a) Net working Capital

Net WC = CURRENT ASSETS - CURRENT LIABILITIES

OR

= INVENTORY + RECIEVABLES - A/C PAYABLES

Both methods gives Net Working Capital,

Second method represents only the “core” accounts that make up working capital in the day-to-day operations of the business.

First Method ;

Net WC = 8400 - 3600

= 4800

Second Method ;

Net WC = 1500 + 4400 - 1600

= 4300

b) Cash Operating Cycle

= Inventory Days + Recievable Days - Payable Days

Inventory Days = Inventory ÷ Cost of Sales × 365

= 1500 ÷ 18000 × 365

= 30.4 days

Receivable Days = Receivables ÷ Credit Sales × 365

= 4400 ÷ 30000 × 365

= 53.5 days

Payable Days = Payables ÷ Cost of Sales × 365

= 1600 ÷ 18000 × 365

= 32.4 days

Therefore,

Cash Operating Cycle = 30.4 days + 53.5 days - 32. 4 days

= 51.5 -> 52 days

c) If Receivable days have been 28 days (Industry Average),then

​​Cash operating cycle = 30.4 + 28 - 32.4

= 26 Days.

Old Cash Operating Cycle is Twice as that of New Cash Operating Cycle, this indicates that the company is taking more time to convert thier assets into cash.

They almost have 54 days of Recievable days compared to industry Average of 28 days, so they have some liquidity issues with the recievables.

Hope the answer is clear and if you need any further information please let me know in the comment below.

Thank you!