- 15 Marks
Question
a. A good working capital policy should facilitate successful achievement of the key short-term financing objectives of an organization.
Required:
Identify the three types of working capital policies of an organization. (5 marks)
b. This Way Ltd is preparing a business plan to apply for a grant from EDAIF for an expansion of its rice production. Current production is 20,000 bags at a variable cost per bag of GHS12.00 and contribution sales ratio is 25%. Variable cost is for purchases. Current receivable days is 30 days and inventory turnover is 12 times. Suppliers allow 15 days credit and the company maintains an absolute cash ratio of 1:1.
The funding support from EDAIF is expected to double the production capacity of the company. Inventory and absolute cash ratios would be maintained but receivables and payables days will increase to 45 days and 30 days respectively. EDAIF policy is to support only the extra working capital needs of applicants.
Required:
Determine the amount that should be applied from EDAIF. (10 marks)
Answer
a. Forms of working capital policy
Restrictive or aggressive approach
With a restrictive policy, current assets are financed through short term funds. Firms with
restrictive working capital policies demonstrate the following:
- Keeping low cash balances and making little investment in marketable securities;
- Making small investments in inventory;
- Allowing few or no credit sales, thereby minimizing accounts receivable. 2 marks
Flexible or conservative approach
Firms that adopt a flexible or conservative approach to the management of working capital to
have a higher investment in current assets. The objective is to reduce the risk of stock out and
to maintain high liquidity. Flexible or conservative approach to working capital management
results in the following:
- Keeping large balances of cash and marketable securities;
- Granting liberal credit terms, which results in a high level of accounts receivable;
- Making large investments in inventory. 2 marks
Moderate approach
This is the middle ground between the conservative and the aggressive approach
b.)
| Working Capital Needs | Current (GHS) | Future (GHS) |
|---|---|---|
| Production (Bags) | 20,000 | 40,000 |
| Selling Price per Bag (GHS 12 / (1 – 0.25)) | 16 | 16 |
| Sales Revenue | 320,000 | 640,000 |
| Purchases (GHS 12 per Bag) | 240,000 | 480,000 |
Current Assets:
| Item | Current (GHS) | Future (GHS) |
|---|---|---|
| Inventory | 20,000 | 40,000 |
| Receivables | 26,301.37 | 78,904.11 |
| Cash | 9,863.01 | 39,452.05 |
| Total Current Assets | 56,164.38 | 158,356.16 |
Current Liabilities:
| Item | Current (GHS) | Future (GHS) |
|---|---|---|
| Payables | (9,863.01) | (39,452.05) |
Working Capital Required:
| Item | Current (GHS) | Future (GHS) |
|---|---|---|
| Working Capital | 46,301.37 | 118,904.11 |
Amount required from EDAIF = 118,904.11 – 46,301.37 =GHS 72,602.74
- Tags: Cash Ratio, Funding, Payables, Receivables, Working Capital Policy
- Level: Level 2
- Topic: Working Capital Management
- Series: NOV 2015
- Uploader: Kwame Aikins