- 25 Marks
FM – L2 – Q116 – Management of Receivables and Payables
Evaluate the impact of a new discount policy on Atefufu Foods Limited’s annual profit and suggest an alternative receivables management policy.
Question
Atefufu Foods Limited has annual sales revenue of GH¢8 million. It has a contribution to sales ratio of 45% and its annual fixed costs are GH¢2.5 million. These figures exclude bad debts which are currently 1.25% of sales. All sales are on credit and standard credit terms are 30 days, although customers take on average 45 days to pay. Accounts receivable are financed by a bank overdraft on which interest is payable at 8%.
The company’s management are considering whether to offer a discount of 2.5% for all customers who pay within 14 days, and to extend the credit period for other customers to 60 days. It has been estimated that if this policy is introduced, 25% of customers would take the settlement discount and the rest would take the full 60 days credit offered.
The new policy would result in higher administration costs equal to 0.5% of total gross sales. It is expected that total (gross) sales would be boosted, and would increase by 3% per year. It is also expected that bad debts would fall to 1% of gross sales.
Required:
(A) Calculate the effect that the new policy would have on annual profit and recommend whether the new policy should be introduced. Suggest an alternative policy for the management of receivables that might improve profit by a larger amount.
(B) Esuna Processing Limited is a subsidiary of Atefufu Foods Limited. It uses the Miller-Orr model to manage its cash balances and has set a minimum cash balance of GH¢12,500. The average rate received on investments is currently 5.68%. Over the past year, the standard deviation of daily cash flows has been GH¢2,800. The cost to the company of selling investments or making deposits is GH¢20 per transaction.
Required:
Calculate the spread, the upper limit and the return point for cash balances using the Miller-Orr model and explain the meaning and purpose of these amounts for the purpose of cash management.
(C) Suggest with reasons how Esuna Processing Limited might invest its short-term cash surpluses.
(D) Discuss the main factors that should be taken into consideration by a company’s management when deciding on how its working capital should be funded.
Find Related Questions by Tags, levels, etc.
- Tags: Financing Policy, Liquidity, Matching Principle, Risk Management, Working Capital Funding
- Level: Level 2
- Topic: Working capital management
