CORPORATE FINANCE (UKFF3013)

JANUARY 2024 TRIMESTER

TUTORIAL 7
SHORT TERM FINANCE AND
THE MANAGEMENT OF WORKING CAPITAL (CHAPTER 3)

QUESTION 1
Discuss briefly the factors which influence the formulation of working capital policy.

Working capital policies can cover the level of investment in current assets, the way in which
current assets are financed, and the procedures to follow in managing elements of working capital
such as inventory, trade receivables, cash, and trade payables.

The two objectives of working capital management are liquidity and profitability, and working
capital policies support the achievement of these objectives.

There are several factors which influence the formulation of working capital policies as follows:

Nature of the business

The nature of the business influences the formulation of working capital policy because it
influences the size of the elements of working capital.

A manufacturing company, for example, may have high levels of inventory and trade receivables,
a service company may have low levels of inventory and high levels of trade receivables, and a
supermarket chain may have high levels of inventory and low levels of trade receivables.

The operating cycle

The length of the operating cycle, together with the desired level of investment in current assets,
will determine the amount of working capital finance needed.

Working capital policies will therefore be formulated to optimise as much as possible the length
of the operating cycle and its components, which are the inventory conversion period, the
receivables conversion period, and payables deferral period.

Terms of trade

Since a company must compete with other companies to be successful, a key factor in the
formulation of working capital policy will be the terms of trade offered by competitors.

The terms of trade must be comparable with those of competitors and the level of receivables will
be determined by the credit period offered and the average credit period taken by customers.

Risk appetite of company

A risk-averse company will tend to operate with higher levels of inventory and receivables than a
company which is more risk-seeking.
Similarly, a risk-averse company will seek to use long-term finance for permanent current assets
and some of its fluctuating current assets (conservative policy), while a more risk-seeking
company will seek to use short-term finance for fluctuating current assets as well as for a portion
of the permanent current assets of the company (an aggressive policy).
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 CORPORATE FINANCE (UKFF3013)
JANUARY 2024 TRIMESTER
TUTORIAL 7
SHORT TERM FINANCE AND
THE MANAGEMENT OF WORKING CAPITAL (CHAPTER 3)

QUESTION 2
Discuss the key elements of a trade receivables management policy.
Receivables levels depend on terms of sales, the ability of the company to finance receivables,
pricing policy and receivables collection procedures.

The advantages of more sales must be balanced against the costs of offering credit, which include
administrative costs like recording, monitoring, and collecting debts, as well as expenses for bad
debt collection and credit insurance.

Moreover, the financial costs of offering credit include investment in receivables and losses due to
bad debts. Credit analysis is based on the company’s own experience, analysis of credit reports
and analysis of published information. When offering credit should reflect assessment of
creditworthiness of prospective client. The credit assessment should consider previous experience
of similar firms, credit reports, analysis of published information. Therefore, the company can
ensure agreed terms of sale are met through periodic review of credit limits, agreed trade
receivables analysis, efficient administration and agreed overdue account procedure.

Receivables management offering early payment discounts can encourage customers to pay early.
However, it is crucial to balance the cost of these discounts against the benefits of lower financing
charges and decreased bad debt risk. The aim is to ensure that the advantages of offering
discounts can exceed the costs.

QUESTION 3
Williams Wholesalers Berhad currently asks its credit customers to pay by the end of the
month after the month of delivery. In practice, customers take rather longer to pay
– on average 70 days. Sales revenue amounts to RM4 million a year and bad debts to
RM20,000 a year.
It is planned to offer customers a cash discount of 2 per cent for payment within 30 days.
Williams estimates that 50 per cent of customers will accept this facility but that the
remaining customers, who tend to be slow payers, will not pay until 80 days after the sale. At
present the business has an overdraft facility at an interest rate of 13 per cent a year. If the
plan goes ahead, bad debts will be reduced to RM10,000 a year and there will be savings in
credit administration expenses of RM6,000 a year.
Should Williams Wholesalers Berhad offer the new credit terms to customers?
Receivables now: RM 4 million x (70/365) = RM767,123.29
Proposed receivables:
RM4 million x 50% x (80/365) = RM438,356.16
RM4 million x 50% x (30/365) = RM164,383.56
RM602,739.72
Decrease in receivables: RM767,123.29 – RM602,739.72 = RM164,383.57
Finance cost saving = 13% x RM164,383.57 = RM21,369.86
Bad debt cost saving (RM20,000 – RM10,000) = RM10,000.00
Administrative cost saving = RM6,000.00
Total Saving: = RM37,369.86
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 CORPORATE FINANCE (UKFF3013)
JANUARY 2024 TRIMESTER
TUTORIAL 7
SHORT TERM FINANCE AND
THE MANAGEMENT OF WORKING CAPITAL (CHAPTER 3)
Discount cost = RM4 million x 2% x 50% = RM40,000
Net cost of new policy = RM37,369.86 – RM40,000 = -RM2,630.14
Since the cost is greater than the saving, the proposal is not worth to implement.

QUESTION 4
T Berhad has annual credit sales of RM4.5 million. Credit terms are 30 days, but its
management of trade receivables has been poor and the average collection period is 50 days,
with 0.4 percent of sales resulting in bad debts.
A factor has offered to take over the task of debt administration and credit checking, at an
annual fee of 1 percent of credit sales. T Berhad estimates that it could save RM35,000 per
year in administrative costs as a result. Due to the efficiency of the factor, the average
collection period would fall to 30 days and bad debts would be eliminated. The factor would
advance 80 percent of invoiced debts at an annual interest rate of 11 percent. T Berhad
currently finances trade receivables from an overdraft costing 10 percent per year.

Required:
If credit sales occur smoothly throughout the year, determine whether the factor’s services
should be accepted. Will accepting the services of the factor maximize shareholders’ wealth?
RM
Current level of trade RM4.5 million x (50/365) 616,438
receivables WITHOUT
FACTOR
Under the factor, trade RM4.5 million x (30/365) 369,863
receivables will fall to
Difference RM616,438 - RM369,863 246,575

The costs of the current policy are:

RM
Cost of financing current RM616,438 x 10% 61,644
receivables
Cost of bad debts RM4.5 million x 0.4% 18,000
Cost of current policy 79,644

The costs under the factor are:

RM
(RM369,863 x 80% x 11%) + (RM369,863 x 20% x 10%) 39,945
Factor’s annual fee RM4.5 million x 1% 45,000
Saved administrative cost given (35,000)
Net cost under factor 49,945
Comment Cost-benefit analysis shows the factor’s services are
cheaper than the current practice by RM29,699 per
year. On financial grounds, the services of the factor
should be accepted as it will maximize shareholders’
wealth.
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 CORPORATE FINANCE (UKFF3013)
JANUARY 2024 TRIMESTER
TUTORIAL 7
SHORT TERM FINANCE AND
THE MANAGEMENT OF WORKING CAPITAL (CHAPTER 3)

QUESTION 5
G Berhad, a manufacturer of steel toys, has annual sales of RM20 million. Cost of goods sold
is 70% of sales, and purchases are 65% of cost of goods sold. All the sales and purchases are
on credit. Assume a 360-day year, and G Berhad has the following ratios:
Average Inventory Holding Period 45 days
Average Payment Period 30 days

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 CORPORATE FINANCE (UKFF3013)
JANUARY 2024 TRIMESTER
TUTORIAL 7
SHORT TERM FINANCE AND
THE MANAGEMENT OF WORKING CAPITAL (CHAPTER 3)
Average Collection Period 25 days
Required:
(i) Compute the Cash Conversion Cycle (CCC) of G Berhad and the amount of net
working capital invested in the CCC.
Cash Conversion Cycle (CCC)
= Inventory Holding Period + Average Collection Period - Average Payment Period
= 45 days + 25 days – 30 days
= 40 days

The amount of net working capital invested in the CCC

= Investment in Inventory + Investment in Accounts Receivable – Investment in Accounts
Payable
= [(RM20 million x 70%) x (45/360)] + (RM20 million x 25/360) – [(RM20 million x 70%
x 65%) x (30/360)]
= RM1,750,000 + RM1,388,888.89 – RM 758,333.33
= RM 2,380,555.56

(ii) If G Berhad wishes to improve its working capital management, recommend FOUR
(4) strategies to improve its CCC.
One strategy to improve its cash conversion cycle (CCC) is to maximize inventory
turnover while avoiding stockouts, which could lead to lost sales. By efficiently
managing inventory levels and ensuring a consistent flow of goods, G Berhad may
reduce holding costs and free up capital for other investments. This can be achieved by
improving forecasts, streamlining procurement processes, and utilizing technologies
such as inventory management systems to monitor stock levels in real-time.

Another key aspect of improving CCC is speeding up the collection of accounts

receivable without using the aggressive tactics that may damage customer
relationships. G Berhad can achieve this by implementing effective invoicing systems,
offering early settlement discounts for early payments, and establishing clear credit
terms. By reducing the time it takes to collect customers payment, the company can
increase cash flow and shorten the cash conversion cycle (CCC).

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 CORPORATE FINANCE (UKFF3013)
JANUARY 2024 TRIMESTER
TUTORIAL 7
SHORT TERM FINANCE AND
- Manage mail,THE
processing, and clearing
MANAGEMENT OFtime to reduceCAPITAL
WORKING them when collecting from
(CHAPTER 3) customers
and to increase them when paying suppliers.
Efficient management of payment processes is also essential in optimizing CCC. G
Berhad can focus on reducing mail, processing, and clearing times associated with both
collecting payments from customers and paying suppliers. This can involve digitizing
payment systems, implementing electronic invoicing and payment methods, and
negotiating favorable payment terms with suppliers. By streamlining these processes,
the company can minimize delays and improve overall efficiency, thereby reducing the
cash conversion cycle.

Pay supplier as slowly as possible without damaging the firm’s credit rating.
Furthermore, G Berhad can strategically manage its payment schedules to pay suppliers
as slowly as possible without jeopardizing its credit rating or supplier relationships. This
approach allows the company to retain cash for longer periods, providing more
flexibility for investments and operational needs. However, it's essential to strike a
balance between extending payment terms and maintaining positive supplier
relationships to ensure a reliable supply chain. By adopting these strategies, G Berhad
can enhance its working capital management and optimize its cash conversion cycle for
improved financial performance.

QUESTION 6
K Berhad is an e-business which trades solely over the internet. In the last year the company
had sales of RM15 million. All sales were on 30 days’ credit to commercial customers.
Extracts from the company’s most recent statement of financial position relating to working
capital are as follows:
RM’00
0
Trade receivables 2,466
Trade payables 2,220
Overdraft 3,000
In order to encourage customers to pay on time, K Berhad proposes introducing an early
settlement discount of 1% for payment within 30 days, while increasing its normal credit
period to 45 days. It is expected that, on average, 50% of customers will take the discount
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and pay within 30 days, 30% of customers will pay after 45 days, and 20% of customers will
not change their current paying behaviour.
 CORPORATE FINANCE (UKFF3013)
JANUARY 2024 TRIMESTER
TUTORIAL 7
SHORT TERM FINANCE AND
THE MANAGEMENT OF WORKING CAPITAL (CHAPTER 3)

K Berhad currently orders 15,000 units per year of Product Z, demand for which is constant.
There is only one supplier of Product Z and the cost of Product Z purchases over the last year
was RM540,000. The supplier has offered a 2% discount for orders of Product Z of 30,000
units or more. Each order costs K Berhad RM150 to place and the holding cost is 24sen per
unit per year. K Berhad has an overdraft facility charging interest of 6% per year.

Required:
a) Calculate the net benefit or cost of the proposed changes in trade receivables policy
and comment on your findings.
Calculation of net cost/benefit

Current receivables RM 2,466,000

Receivables paying within 15M X 0.5X30/365 616,438
30 days (sales x % x
days/360)

Receivables paying within 15M X 0.3X45/365 554,795

45 days
Receivables paying within 15M X 0.2 X 60/365 493,151
60 days
Revised receivables 616,438 + 554,795 + 493,151 1,664,384
Reduction in receivables 2,466,000 - 1,664,384 801,616
Reduction in financing cost 801,616 X 0.06 (BENEFIT) 48,097
Cost of discount 15M X 0.5 X 0.01 (COST) 75,000

Net cost of proposed changes 75,000-48,097 (NET COST) 26,903

in receivables policy

Alternative approach to calculation of net cost/benefit

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 CORPORATE FINANCE (UKFF3013)
JANUARY 2024 TRIMESTER
TUTORIAL 7
SHORT TERM FINANCE AND
THE MANAGEMENT OF WORKING CAPITAL (CHAPTER 3)
Current receivables days (2466/1500) X365 60 DAYS
Revised receivables days (30*0.5) + (45*0.3) + (60*0.2) 40.5DAYS
Decrease in receivables 60 - 40.5 19.5days
days
Decrease in receivables 15M X 19.5/365 801,370
(The slight difference compared to the earlier answer is due to rounding)
Decrease in financing cost 801,370 x0.06 48,082
Net cost of proposed changes 75,000(cost)-48,082 26,918
in receivables policy (benefit) = net cost
Comment:
The proposed changes in TR policy are not financially acceptable.
However, if the trade terms offered are comparable with those of its competitors,
KXP Co. needs to investigate.

b) Calculate whether the bulk purchase discount offered by the supplier is financially
acceptable and comment on the assumptions made by your calculation.
Cost of current inventory policy
Cost of materials RM540,000 per
year
Annual ordering cost 12orders x 150 RM 1,800 per year
Annual holding cost 0.24 x (15,000/2) 1,800 per year

Total cost of current 540,000+1800+1800 543,600 per year

inventory policy
Cost of inventory policy after bulk purchase discount

Cost of materials after bulk 540,000*0.98 529,200 per year

purchase discount
Annual demand 12*150,000 180,000 units per
year

K Berhad will need to increase its order size to 30,000 units to gain the bulk
discount
Revised number of orders 180,000/30,000 6 orders per year
Revised ordering cost 6 x 150 RM 900 per year
Revised holding cost 0.24 x (30,000/2) RM 3,600 per year
Revised total cost of 529,200+900+3600 533,700 per year

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 CORPORATE FINANCE (UKFF3013)
JANUARY 2024 TRIMESTER
TUTORIAL 7
SHORT TERM FINANCE AND
THE MANAGEMENT OF WORKING CAPITAL (CHAPTER 3)

inventory policy
- net benefit of taking benefit discount= 543,600 – 544,700 = 9,900
Financial acceptable but it is based on a number of unrealistic assumptions.

QUESTION 7
V Berhad sells stationery and office supplies on a wholesale basis and has an annual revenue of
RM4 million. The company employs four people in its sales ledger and

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 CORPORATE FINANCE (UKFF3013)
JANUARY 2024 TRIMESTER
TUTORIAL 7
SHORT TERM FINANCE AND
THE MANAGEMENT OF WORKING CAPITAL (CHAPTER 3)

credit control department at an annual salary of RM12,000 each. All sales are on 40 days’
credit with no discount for early payment. Bad debts represent 3% of revenue and V Berhad
pay annual interest of 9% on its overdraft. The most recent accounts of the company offer the
following information:

RM’000 RM’000
Non-current assets
Tangible non-current assets 17,500
Current assets
Inventory of goods for resale 900
Receivables 550
Cash 120
1,570
Total assets 19,070

Equity and liabilities

Ordinary shares 3,500
Reserves 11,640
15,140
Non-current liabilities
12% bonds due 20Y0 2,400

Current liabilities
Trade payables 330
Overdraft 1,200
1,530
Total equity and liabilities 19,070

V Berhad is considering offering a discount of 1% to customer paying within 14 days, which

it believes will reduce bad debts to 2.4% of revenue. The company also expects that offering
a discount for early payment will reduce the average credit period taken by customers to 26
days. The consequent reduction in time spent chasing customers where payment are overdue
will allow one member of the credit control team to take early retirement. Two-thirds of
customers are expected to take advantage of the discount.
Required:
Using the information provided, determine whether a discount for early payment of 1 per cent
will lead to an increase in profitability for V Berhad.

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