Question

QUESTION TWO
The following information was extracted from ABC Ltd’s financial statements for the year ended 31 December 2019.

a. Sales on 30 November 2019 were K100 million and K110 million on 31 December 2019. For the year 2020, sales are expected to double at a constant monthly rate.
b. 80% of the sales made are on account; the remainder on cash.
c. From past experience, 5% of the receivables have turned out to be irrecoverable.
d. Credit customers pay as follows:
i. 75% in the month following the sale;
ii. 15% two months after the sale month.
e. Inventory levels are maintained at 20% of the following month’s sales.
f. Accounts payables are at settled at 30 days after purchase.

Required:
i. Prepare a collections schedule for the three-month period from January to March 2020.
[5 Marks]
ii. Prepare a cash forecast for the three-month period from January to March 2020.
[5 Marks]
iii. Assess the Operating Cycle ratios and their implication on the working capital requirements of the company for the forecast period.
        

Answer 1

Part-1:Prepare a collections schedule for the three-month period from January to March 2020.

Summary of above calculation:

for calculation of collection from sales remeber following points:

1. Colection is related with sales made during a period so above calculation is based on total estimated sales given in example.

2. Her sales from jan-20 to March-20 will be double at a constant monthly rate. For that base year considered is Dec-2019.

3. Total collection means collectionby way of cash sales and collection from trade receivables to whom goods sold on credit.

4. Cash sales received in same month only.

5. For credit sale collection is made according to the credit period given which is 75% in next month and 15% in second month after sale. Nothing is given about remaining 10% so keep it as irecovered credit sales.

6.Following statement showing working note for calculation of collection on sales:

Part-2: Prepare a cash forecast for the three-month period from January to March 2020.

Cash forcast means total collection minus total payment for the specific month. Following is the statement showing cash forecast for the three month ending on march-2020

Summary: Here opening cash balance for the month January-2020 it comes by adding 22 cash sales + 57 from credit sales Less: Payment for credit purchases of 22.

Part-3:

Operating Cycle is an activity ratio measuring the amount of time needed by a firm to turn its inventories into cash. This indicator can be computed by summing the inventory turnover (days) and the accounts receivable turnover (days).

Whereas working capital means difference between current assets and current liabilities. High inventory turnover days indicate that inventory converted into cash is very slow and it also affect on working capital. Because high inventory leads requirement of excess working capital.