Tag (SQ): Funding Policy

Tamale Transport Ltd has annual sales revenue of GH¢6 million, and all sales are on 30 days’ credit, although customers on average take ten days more than this to pay. Contribution represents 60% of sales, and the company currently has no bad debts. Accounts receivable are financed by an overdraft at an annual interest rate of 7%.
Tamale Transport Ltd plans to offer an early settlement discount of 1.5% for payment within 15 days and to extend the maximum credit offered to 60 days. The company expects that these changes will increase annual credit sales by 5%, while also leading to additional incremental costs equal to 0.5% of turnover. The discount is expected to be taken by 30% of customers, with the remaining customers taking an average of 60 days to pay.

Required:
(A) Evaluate whether the proposed changes in credit policy will increase the profitability of Tamale Transport Ltd.

(B) Salaga Enterprises, a subsidiary of Tamale Transport Ltd, has set a minimum cash account balance of GH¢7,500. The average cost to the company of making deposits or selling investments is GH¢18 per transaction, and the standard deviation of its cash flows was GH¢1,000 per day during the last year. The average interest rate on investments is 5.11%.

Required:
Determine the spread, the upper limit, and the return point for the cash account of Salaga Enterprises using the Miller-Orr model and explain the relevance of these values for the cash management of the company.

(C) Identify and explain the key areas of accounts receivable management.

(D) Discuss the key factors to be considered when formulating a working capital funding policy.