Question

a) What are the two major sources of spontaneous short-term financing for a firm? How do their balances behave relative to the firm's sales?

b) Fauzan's fishing products is analyzing the performance of its cash management. On average, the firm holds inventory for 65 days, pays its suppliers in 35 days, and collects receivables in 15 days. The firm has a current annual outlay of RM1,960,000 on operating cycle investments. Fauzan currently pays 10 percent for its financing. (Assume a 360-day year)
i. Calculate the firm's cash conversion cycle
ii. Calculate the firm's operating cycle
iii. Calculate the daily expenditure and the firm's annual savings if the operating cycle is reduced by 15 days.

c.) Layang Incorporation uses 800 units of a product per year on a continuous basis. The product has carrying costs of RM250 per unit per year and order costs of RM300 per order. It takes 30 days to receive a shipment after an order is placed and the firm requires a safety stock of 5 days usage in inventory.

i. Calculate Layang Incorporation's economic order quantity (EOQ)
ii. Calculate Layang Incorporation's reorder point. (Assume a 360-day year)

Answer 1

Answer : (a.) The two major sources of spontaneous short-term financing for a firm are Trade Credit (Bills payable) and Accruals (Outstanding Expenses).Basically  Spontaneous financing refers to financing which arises from day to day operations.

The balances of Trade Credit (Bills payable) and Accruals is positively related with sales. When The sales increases these balances also increases with incresed sales becauses when sales increases , there is increased purchases, wages and other expenses and if company purchases on credit than creditors balance increases. So these balance increases when firm's sales increases and decreases when firm's sales decreases.

Answer (b.) (i)Firm's Cash Conversion Cycle = Inventory Holding Period + Average Receivable period - Average Collection Period

= 65 + 15 - 35

= 45 days

(ii) Firm's Operating Cycle = Inventory Holding Period + Average Receivable period

= 65 + 15

= 80 days

(iii.)Daily Expenditure = Annual Outlay / Number of days

= 1960000 / 360

= 5444.44

Annual Saving = Daily Expenditure * Receivable period * Interest rate

= 5444.44 * 15 * 0.10

= 8166.67

(c.) (i.) Economic Order Quantity = { (2 * Annual Demand * Cost per order) / Carrying Cost}^(1/2)

= { (2 * 800 * 300) / 250 }^(1/2)

= 43.8178046004 or 44 units

(ii) Reorder Point = (Safety stock days + Lead time) * Average Usage

= (5 + 30) * (800 / 360)

= 35 * 2.2222

= 77.78 or 78 units