FINANCIAL MANAGEMENT – Page 3

FM – L2 – Q112 – Management of receivables and payables

Calculate the profit impact of using a debt factor for Nsawkaw Tech Solutions Limited and comment on the findings.

Question

Nsawkaw Tech Solutions Limited is a software business owned and managed by computer software specialists. Although sales have remained stable at GH¢40,000,000 per annum in recent years, the level of trade receivables has increased significantly. A recent financial report submitted to the owners indicates an average settlement period of 60 days for trade receivables compared with an industry average of 40 days. The level of bad debts has also increased in recent years, and the company now writes off approximately GH¢40,000 in bad debts each year.
The recent problems experienced in controlling credit have led to a liquidity crisis for the company. At present, the company finances its trade receivables by a bank overdraft at an interest rate of 14% a year. However, the overdraft limit has been exceeded on several occasions in recent months, and the bank is now demanding a significant decrease in the size of the overdraft.
To meet this demand, the owners of the company have approached a factor who has offered to make an advance payment equivalent to 85% of trade receivables, based on the assumption that the level of receivables will be in line with the industry average.
The factor will charge a rate of interest of 12% a year for this advance. The factor will take over the sales records of the company and, for this service, will charge a fee based on 2% of sales. The company believes that the services offered by the factor should eliminate bad debts and lead to administrative cost savings of GH¢52,000 per year.

Required
(a) Calculate the effect of employing a debt factor on the profit of Nsawkaw Tech Solutions Limited. Comment on your findings.

Note: You may assume 360 days in a year.

(b) State FIVE potential advantages and TWO disadvantages of using the services of a debt factor by a business organisation.

Answer

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Tags: Advantages, Business Operations, Credit Control, Debt Management, Disadvantages, Factoring
Level: Level 2

Topic: Management of receivables and payables

FM – L2 – Q111 – Management of receivables and payables

Calculate the annual interest cost of offering a 2% settlement discount for payment within 7 days, given a 90-day credit period.

Question

(A). A business entity offers its customers trade credit of 90 days. It is considering whether to offer a settlement discount of 2% for payment within seven days.

Required

Calculate the cost of offering the discount, as an annual interest cost.

(B). Entity K has monthly sales of GH₵100,000. A factor has offered to take over the administration of Entity K’s trade receivables, on a non-recourse basis (or without recourse basis). It would charge a fee of 4% of the value of invoices processed. If the factor takes over this work, Entity K would save monthly administration costs of GH₵2,000 and would avoid its bad debts, which are 0.75% of sales.

Entity K has been informed by the factor that the average collection period (the time between issuing an invoice and receiving payment from the customer) will be reduced from 2 months to 1 month.

The factor will also provide finance by lending 80% of the value of unpaid invoices, charging interest at an annual rate of 8% on the cash that it lends. At the moment, Entity K finances its trade receivables with bank overdraft finance at 9% per year interest.

Required

Calculate the net effect on annual profits of Entity K if the factor took over the administration of the trade receivables and provided finance on the terms described above.

Answer

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Tags: Bad Debts, Cost-benefit analysis, Credit administration, Factoring, Interest cost, Non-recourse factoring, Trade Receivables
Level: Level 2

Topic: Management of receivables and payables

L2 – Q110 – Trade Receivables Management

Calculate the effect of reducing credit period on Entity N's annual profit, considering sales reduction, bad debts, and overdraft costs.

Question

Entity N is reviewing its credit policy. It is estimated that if the period of credit allowed to customers is reduced to 60 days, there will be a 25% reduction in annual sales, but bad debts would be reduced by GH¢30,000 each year. It would also be necessary to spend an extra GH¢20,000 each year on credit control. Entity N has cash flow difficulties and relies on overdraft finance, for which the interest rate is 9%.

Required
Calculate the effect of these changes on the annual profit. Base your answer on the level of sales in Year 3, and assume that purchases and inventory would be reduced in the same proportion as the reduction in sales.

Entity N – Extracts from annual accounts	Year 3
Inventory	GH¢
Raw materials	180,000
Work in progress	93,360
Finished goods	142,875
Purchases	720,000
Cost of goods sold	1,098,360
Sales	1,188,000
Trade receivables	297,000
Trade payables	126,000

Answer

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Tags: Bad Debts, Credit Control, Credit Policy, Overdraft Finance, Profit Impact, Sales Reduction, Trade Receivables, Working Capital
Level: Level 2

Topic: Management of receivables and payables

FM – L2 – Q109 – Inventory Management

Calculate the EOQ for an item with given demand, costs, and holding expenses to minimize annual costs.

Question

Entity G uses 105 units of an item of inventory every week. These cost GH₵150 per unit. They are stored in special storage units and the variable costs of holding the item is GH₵4 per unit each year plus 2% of the inventory’s cost.

Required
(a) If placing an order for this item of material costs GH₵390 for each order, what is the optimum order quantity to minimise annual costs? Assume that there are 52 weeks in each year.

(b) Suppose that the supplier offers a discount of 1% on the purchase price for order sizes of 2,000 units or more. What will be the order size to minimise total annual costs?

Answer

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Tags: Cost Optimization, Discount Analysis, Economic Order Quantity, Inventory Management
Level: Level 2

Topic: Inventory Management

FM – L2 – Q108 – Inventory Management

Calculate the average stock level for a component based on usage and lead time data.

Question

Ravens Limited (RV) imports a high-value component for its manufacturing process. The following data, relating to the component, has been extracted from RV’s records for the last twelve months:

Maximum usage in a month	300 units
Minimum usage in a month	150 units
Average usage in a month	225 units
Maximum lead time	6 weeks
Minimum lead time	2 weeks

Required
Calculate the average stock level for the component.

Answer

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Tags: Inventory Management, Lead Time, Reorder Level, Stock Levels, Usage Rates
Level: Level 2

Topic: Inventory Management

FM – L2 – Q107 – Inventory Management

Evaluate if Kweku Ltd should accept a foreign supplier's discount offer for groundnut orders, comparing EOQ and special order costs.

Question

Kweku Ltd, a manufacturer of groundnut paste, is evaluating whether to continue with its economic order quantity (EOQ) or accept a special order from a foreign supplier for groundnut purchases. The relevant financial data is provided below:

Description	Value
Purchase price per bag of groundnut	GH¢360
Holding cost per annum (10% of the cost of a bag of groundnut)	GH¢36
Ordering cost per order	GH¢7.70
Annual demand of groundnut paste	6,240 bags
Normal usage per month	520 bags
Minimum usage per month	Not specified
Maximum usage	Not specified

Required:
The foreign supplier offers an 8% reduction in the price per bag of groundnut if Kweku Ltd orders 3,000 bags each time. Advise Kweku Ltd on whether to accept the supplier’s offer.

Answer

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Tags: Cost analysis, Economic Order Quantity, Groundnut Paste Manufacturing, Inventory Management, Supplier Discount
Level: Level 2

Topic: Inventory Management

FM – L2 – Q106 – Inventory Management

Calculate EOQ, costs, and order frequency for Nana Kofi Ltd; explain stock motives and EOQ relevance

Question

NANA KOFI LIMITED
(a) What are the two most relevant costs for determining the economic order quantity? Give THREE (3) specific examples in each case.

(b) Examine the THREE (3) motives for holding stocks.

(d) Nana Kofi Limited purchases and sells CDs. The company has been experiencing stock shortages and excess stocks at certain times in the year. The manager is concerned about the impact of overstocking and understocking and is therefore requesting you to assist in determining the most Economic quantity of CDs to order.
He has made the following information available to you to enable you to recommend an appropriate stock to order and hold.

GH¢
Sales per annum	20,000,000
Units of items sold	200,000 units
Mark up on cost of purchases is 25% of purchase price
The ordering cost is GH¢200 per order whilst holding cost per unit is 5% of unit price.

Required:
(i) Determine the economic order quantity.

(ii) What is the annual ordering cost?

(iii) Determine the annual holding cost

(iv) How many times in a year will the company order for goods?

(v) What is the purchase value per order quantity?

Answer

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Level: Level 2

Topic: Inventory Management

FM – L2 – Q104 – Working Capital Management

Analyze Peak Enterprises Limited's financial statements to determine if it is overtrading and discuss its implications.

Question

Peak Enterprises Limited is a small manufacturing company. Its summarized accounts for the last two years are presented below:

Statements of Financial Position as at 31st March

	Year 5 (GH¢’000)	Year 6 (GH¢’000)
Fixed Assets	1,130	1,080
Current Assets
Inventory	210	260
Trade Receivables	120	160
Cash	30	–
Total Current Assets	360	420
Total Assets	1,490	1,500
Equity and Liabilities
Equity Shares of GH¢0.25	200	200
Accumulated Profits	680	500
Total Equity	880	700
Medium-Term Bank Loan	200	150
Current Liabilities
Bank Overdraft	140	250
Trade Payables	200	280
Other Payables	70	120
Total Current Liabilities	410	650
Total Equity and Liabilities	1,490	1,500

Statements of Profit or Loss for the Year Ending 31st March

	Year 5 (GH¢’000)	Year 6 (GH¢’000)
Sales	1,800	2,900
Gross Profit	210	260
Profit Before Tax	120	160
Taxation	(30)	(40)

Required
(a) Comment on whether there is any evidence that Peak Enterprises Limited is overtrading.
(b) Discuss the implications of overtrading for Peak Enterprises Limited.

Answer

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Tags: Bank Overdraft, Cash Flow, Equity financing, Financial Ratios, Inventory Management Civilian Financial Statements, Overtrading, Trade Payables, Trade Receivables, Working Capital
Level: Level 2

Topic: Working capital management

FM – L2 – Q103 – Working capital management

Calculate the working capital cycle length for Entity N over three years using provided financial data.

Question

The working capital (or cash operating) cycle of a business is the length of time between the payment for purchased materials and the receipt of payment from selling the goods made with the materials.
The table below gives information extracted from the annual accounts of Entity N for the past three years.

Entity N – Extracts from annual accounts

	Year 1	Year 2	Year 3
	GH¢	GH¢	GH¢
Inventory:
Raw materials	108,000	145,800	180,000
Work in progress	75,600	97,200	93,360
Finished goods	86,400	129,600	142,875
Purchases	518,400	702,000	720,000
Cost of goods sold	756,000	972,000	1,098,360
Sales	864,000	1,080,000	1,188,000
Trade receivables	172,800	259,200	297,000
Trade payables	86,400	105,300	126,000

Required
(a) Calculate the length of the working capital cycle (assuming 365 days in the year).

(b) List the actions that the management of Entity N might take to reduce the length of the cycle.

Answer

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Tags: Cash Operating Cycle, Credit Management, Inventory Management, Payables Management, Working Capital Cycle
Level: Level 2

Topic: Working capital management

FM – L2 – Q102 – Treasury management

PrimeCare Inc supplies medical goods to HealthBridge Ltd in Ghana, addressing credit and currency risks in a $3M contract.

Question

PrimeCare Inc, a company in the USA, has agreed a contract to supply medical supplies to HealthBridge Ltd, a large hospital group based in Ghana. The price of the contract is $3 million.
There is currently no existing relationship between the two companies and PrimeCare has no other customers in Ghana.

Required:
Explain how PrimeCare Inc can manage the credit risk and currency risk associated with this international transaction.

Answer

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Tags: Credit risk, Currency hedging, Foreign Exchange Risk, Forward Contract, International payments, Letter of credit, Treasury management
Level: Level 2

Topic: Treasury Management

Subject (SQ): FINANCIAL MANAGEMENT

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FM – L2 – Q112 – Management of receivables and payables

Calculate the profit impact of using a debt factor for Nsawkaw Tech Solutions Limited and comment on the findings.

FM – L2 – Q111 – Management of receivables and payables

Calculate the annual interest cost of offering a 2% settlement discount for payment within 7 days, given a 90-day credit period.

L2 – Q110 – Trade Receivables Management

Calculate the effect of reducing credit period on Entity N's annual profit, considering sales reduction, bad debts, and overdraft costs.

FM – L2 – Q109 – Inventory Management

Calculate the EOQ for an item with given demand, costs, and holding expenses to minimize annual costs.

FM – L2 – Q108 – Inventory Management

Calculate the average stock level for a component based on usage and lead time data.

FM – L2 – Q107 – Inventory Management

Evaluate if Kweku Ltd should accept a foreign supplier's discount offer for groundnut orders, comparing EOQ and special order costs.

FM – L2 – Q106 – Inventory Management

Calculate EOQ, costs, and order frequency for Nana Kofi Ltd; explain stock motives and EOQ relevance

FM – L2 – Q104 – Working Capital Management

Analyze Peak Enterprises Limited's financial statements to determine if it is overtrading and discuss its implications.

FM – L2 – Q103 – Working capital management

Calculate the working capital cycle length for Entity N over three years using provided financial data.

FM – L2 – Q102 – Treasury management

PrimeCare Inc supplies medical goods to HealthBridge Ltd in Ghana, addressing credit and currency risks in a $3M contract.

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Calculate the profit impact of using a debt factor for Nsawkaw Tech Solutions Limited and comment on the findings.

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Calculate the annual interest cost of offering a 2% settlement discount for payment within 7 days, given a 90-day credit period.

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Calculate the effect of reducing credit period on Entity N's annual profit, considering sales reduction, bad debts, and overdraft costs.

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Calculate the EOQ for an item with given demand, costs, and holding expenses to minimize annual costs.

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Calculate the average stock level for a component based on usage and lead time data.

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Evaluate if Kweku Ltd should accept a foreign supplier's discount offer for groundnut orders, comparing EOQ and special order costs.

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Calculate EOQ, costs, and order frequency for Nana Kofi Ltd; explain stock motives and EOQ relevance

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Analyze Peak Enterprises Limited's financial statements to determine if it is overtrading and discuss its implications.

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Calculate the working capital cycle length for Entity N over three years using provided financial data.

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PrimeCare Inc supplies medical goods to HealthBridge Ltd in Ghana, addressing credit and currency risks in a $3M contract.

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