Final Project

Financial Management
Chapter #15
Submitted by:
Mehwish Imran (L1F22BBAM0417)
Javeria Naseer (L1F24PADB0011)
Maheen Yousuf (L1F24PADB0012)
Nabeel Mushtaq (L1F22BBAM0419)
Ahad Ishaq (L1F22BBAM0210)
Shah Fahad (L1F22BBAM0219)
Rana Saif Ali (L1F22BBAM0562)
 Chapter 15
Working Capital and Current Assets Management

Working capital refers to the short-term assets and liabilities of a company that are used in its
day-to-day operations. It is calculated as:

Working Capital=Current Assets−Current Liabilities

Net working capital represents the difference between current assets (such as cash, accounts
receivable, and inventory) and current liabilities (such as accounts payable and short-term debt).

Significance of Working Capital in Finance

1. Ensures Liquidity

Sufficient working capital helps a company meet its short-term financial obligations,
preventing liquidity crises.

2. Smooth Business Operations

Proper management of working capital ensures uninterrupted production and sales cycles.

3. Financial Stability

A healthy working capital balance enhances a firm's ability to handle unexpected

expenses or downturns.

4. Improves Creditworthiness

Companies with strong working capital management are more likely to secure short-term
loans or credit from suppliers.

5. Enhances Profitability

Efficient working capital management reduces unnecessary holding costs of inventory

and minimizes borrowing costs.

6. Supports Growth and Expansion

A positive working capital position provides funds for business expansion, investment,
and strategic opportunities.

7. Reduces Financial Risk

Managing working capital efficiently helps prevent insolvency and financial distress.
Net working capital
The difference between the firm’s current assets and its current liabilities.
NWC=Current Assets−Current Liabilities
Indicates the short-term financial health of a company.

Current Ratio:

Current assets
Current Ratio=
Current Liabilites

Measures a firm's ability to pay short-term obligations. A ratio above 1 is generally favorable.

Profitability
The relationship between revenues and costs generated by using the firm’s assets— both current
and fixed—in productive activities.

Risk (of insolvency)

The probability that a firm will be unable to pay its bills as they come due.

Cash Conversion Cycle (CCC)

The length of time required for a company to convert cash invested in its operations to cash
received as a result of its operations.
CCC=
Days Inventory Outstanding (DIO)+Days Sales Outstanding (DSO)−Days Payables Outsta
nding (DPO)
Measures the time taken to convert resources into cash flow.

Operating Cycle (OC)

The time from the beginning of the production process to collection of cash from the sale of the
finished product.
Operating Cycle=DIO+DSO

Represents the time taken to convert raw materials into cash received from sales.
 QUESTION # 01
Cash conversion cycle American Products is concerned about managing cash efficiently. On the
average, inventories have an age of 90 days, and accounts receivable are collected in 60 days.
Accounts payable are paid approximately 30 days after they arise. The firm has annual sales of
about $30 million. Assume there is no difference in the investment per dollar of sales in
inventory, receivables, and payables and that there is a 365-day year.
a. Calculate the firm’s operating cycle.
b. Calculate the firm’s cash conversion cycle.
c. Calculate the amount of resources needed to support the firm’s cash conversion cycle.
d. Discuss how management might be able to reduce the cash conversion cycle.
Solution:

Given Data:

 Inventory period = 90 days

 Accounts receivable period = 60 days
 Accounts payable period = 30 days
 Annual Sales = $30 million
 Year length = 365 days

(a) Calculate the firm’s Operating Cycle (OC):

The Operating Cycle (OC) is the time taken to convert raw materials into cash from sales. It is
calculated as:

Operating Cycle=Inventory Period +Accounts Receivable Period

OC= 90+60
=150 days
(b) Calculate the firm’s Cash Conversion Cycle (CCC):

The Cash Conversion Cycle (CCC) is the time between when the company pays for materials
and when it receives cash from sales. It is calculated as:

CCC=Operating Cycle−Accounts Payable Period

CCC=150−30
=120 days
c) Resources needed to support the Cash Conversion Cycle:

30 ; 000,000
Daily sales=
365
=82,192
Investment in CCC=120 × 82,192
=9,836,014
d) Discussion on Reducing the Cash Conversion Cycle:
 Reduce inventory age by improving stock management.
 Speed up receivables collection (e.g offer discounts for early payments)
 Extend account payable periods strategically.

Question # 02
Changing cash conversion cycle Camp Manufacturing turns over its inventory eight times each
year, has an average payment period of 35 days, and has an average collection period of 60 days.
The firm’s annual sales are $3.5 million. Assume there is no difference in the investment per
dollar of sales in inventory, receivables, and payables and that there is a 365-day year.
a. Calculate the firm’s operating cycle and cash conversion cycle.
b. Calculate the firm’s daily cash operating expenditure. How much in resources must be
invested to support its cash conversion cycle?
c. If the firm pays 14% for these resources, by how much would it increase its annual profits by
favorably changing its current cash conversion cycle by 20 days?
Solution:

Given Data:

 Inventory Turnover Ratio = 8 times per year

 Average Collection Period = 60 days
 Average Payment Period = 35 days
 Annual Sales = $3,500,000
 Year Length = 365 days

(a) Calculate the Operating Cycle (OC) and Cash Conversion Cycle (CCC):

365
Inventory Period=
Inventory Turnover
 365
= = 45.63 =46 days
8
Operating cycle= Inventory age + Receivable collection Period
=46 + 60
= 106 days
Cash Conversion Cycle = Operating Cycle – Account Payable Period
=106 – 35
= 71 days
(b) Daily Cash Operating Requirement and Resources Needed:
3,500,000
Daily Sales =
365
= 9,589
Investment in CCC = 71 × 9,589
= 681,819

(c) Impact of Reducing CCC by 20 Days (If Firm Pays 14% on Resources):
New CCC= 71 - 20= 51days
New Investment=51 × 9,589=489,039
Savings = 681,819 – 489,039 =192,780
Annual Interest Saving = 14% × 192,780=26,989
Increase in Profit =$26,989

Question # 03
Multiple changes in cash conversion cycle Garrett Industries turns over its inventory six times
each year; it has an average collection period of 45 days and an average payment period of 30
days. The firm’s annual sales are $3 million. Assume there is no difference in the investment per
dollar of sales in inventory, receivables, and payables; and assume a 365-day year.
a. Calculate the firm’s cash conversion cycle, its daily cash operating expenditure, and the
amount of resources needed to support its cash conversion cycle.
b. Find the firm’s cash conversion cycle and resource investment requirement if it makes the
following changes simultaneously. (1) Shortens the average age of inventory by 5 days. (2)
Speeds the collection of accounts receivable by an average of 10 days. (3) Extends the
average payment period by 10 days.
c. If the firm pays 13% for its resource investment, by how much, if anything, could it
increase its annual profit as a result of the changes in part b?
d. If the annual cost of achieving the profit in part c is $35,000, what action would you
recommend to the firm? Why?
Solution:

Given Data:
 Inventory Turnover = 6 times per day
 Collection Period =45 days
 Payment Period= 30 days
 Annual sales = 3 Million
 365-day year assumption
(a)Calculate Cash Conversion Cycle and Resources needed:
365
Inventory age = =60.83 = 61days
6
Operating cycle = 61 + 45 =106 days
Cash Conversion Cycle= 106 – 30 =76 days
3,000,000
Daily Sales = =8,219
365
Investment in CCC = 76 × 8,219 = 624,664
(b) New CCC after Changes:
1. Inventory reduced by 5 days:
New Inventory age = 61 - 5 =56

2. Receivable Collection improved by 10 days:

New Collection Period = 45 – 10 =35

3. Payment period extended by 10 days:

New Payment Period = 30 + 10 = 40
New Operating Cycle = 56 + 35 = 91
New Cash Conversion Cycle= 91 -40 =51 day
New investment = 51 × 8,219 =419,169
Reduction in Investment = 624,664 – 419,169 =205,495
(c) Increase in Profit (if Firm pays 13% for Investment):
Annual Savings = 13% × 205,495= 26,714
(d) Decision Based on $35,000 Cost:
 Savings= $26,714
 Cost =$35,000 (higher than savings)
 Not recommended, unless additional non-monetary benefits exist.

Question # 09
A firm is evaluating an accounts receivable change that would increase bad debts from 2% to 4%
of sales. Sales are currently 50,000 units, the selling price is $20 per unit, and the variable cost
per unit is $15. As a result of the proposed change, sales are forecast to increase to 60,000 units.
a. What are bad debts in dollars currently and under the proposed change?
b. Calculate the cost of the marginal bad debts to the firm.
c. Ignoring the additional profit contribution from increased sales, if the proposed change saves
$3,500 and causes no change in the average investment in accounts receivable, would you
recommend it? Explain.
d. Considering all changes in costs and benefits, would you recommend the proposed change?
Explain
e. Compare and discuss your answers in parts c and d.
Solution:
Given Data:
 Current Sales Volume = 50,000 units
 Selling Price per Unit = $20
 Variable Cost per Unit = $15
 Current Bad Debt Rate = 2%
 New Bad Debt Rate = 4%
 New Sales Volume (Proposed Change) = 60,000 units

(a)Current and Proposed Bad Debt Amount in Dollar:

Current Bad Debts= 2% × (50,000× 20) = 20,000

Proposed Bad Debts = 4% × (60,000 × 20) = 48,000

Increased in Bad Debt= 48,000 – 20,000= 28,000
(b) Current and Bad Debts in Dollar:
Cost of Marginal Bad Debts= Increase in Bad Debt =28,000
(c)Ignoring other Effects, Would You Recommend?
The changes saves $3,500, but additional bad debts are $28000 not recommended.
(d) Considering all changes, should it be recommended?
 Additional profit from increased sales need to be compared with additional bad debts.
 If profit gain ¿ bad debts, accept, otherwise reject.

Question # 10
Lewis Enterprises is considering relaxing its credit standards to increase its currently sagging
sales. As a result of the proposed relaxation, sales are expected to increase by 10% from 10,000
to 11,000 units during the coming year; the average collection period is expected to increase
from 45 to 60 days; and bad debts are expected to increase from 1% to 3% of sales. The sale
price per unit is $40, and the variable cost per unit is $31. The firm’s required return on equal-
risk investments is 25%. Evaluate the proposed relaxation, and make a recommendation to the
firm. (Note: Assume a 365-day year.)
Solution:

Given Data:

 Current Sales Volume = 10,000 units

 New Sales Volume (After Relaxation) = 11,000 units
 Selling Price per Unit = $40
 Variable Cost per Unit = $31
 Current Average Collection Period = 45 days
 New Average Collection Period = 60 days
 Current Bad Debt Rate = 1%
 New Bad Debt Rate = 3%

(a)Additional profit from Sales:

Increase in Sales=1000×(40 – 31) =9000

(b)Increase in Bad Debt Cost:

Current Bad Debt= 1% ×(10,000×40) =4,000

New Bad Debt=3% × (11,000 × 40) =13,200

Increase in Bad Debt= 13,200 – 4,000 = 9,200

(c) Marginal Investment in Account Receivable:

 45
Current A/R= × (10,000 × 40) = 49,315
365

60
New A/R= × (11,000 × 40) =72,329
365

Increase in A/R= 72,329 – 49,315= 23,014

(d) Cost of Additional A/R Investment:

Cost = 25% × 23,014= 5,754

(e) Decision:

 Additional Profit = $9,000

 Increase in Bad Debt + Investment Cost = $9200 + 5754= $14,954
 Net Effect= 9,000 – 14,954 = -5954 (negative impact)
 Not recommended

QUESTION # 11

Gardner Company currently makes all sales on credit and offers no cash discount. The firm is
considering offering a 2% cash discount for payment within 15 days. The firm’s current average
collection period is 60 days, sales are 40,000 units, selling price is $45 per unit, and variable cost
per unit is $36. The firm expects that the change in credit terms will result in an increase in sales
to 42,000 units, that 70% of the sales will take the discount, and that the average collection
period will fall to 30 days. If the firm’s required rate of return on equal-risk investments is 25%,
should the proposed discount be offered? (Note: Assume a 365-day year.)

Solution:

Given Data:

 Current Sales Volume = 40,000 units

 New Sales Volume (After Discount) = 42,000 units
 Selling Price per Unit = $45
 Variable Cost per Unit = $36
 Current Average Collection Period = 60 days
 New Average Collection Period = 30 days
 Percentage of Sales Taking Discount = 70%
 Cash Discount Offered = 2%
 Required Return on Investment = 25%

(a)Calculate Additional Revenue and Contribution Margin:

Current Revenue:
Current Revenue=40,000×45=1,800,000

New Revenue:

New Revenue=42,000×45=1,890,000

Increase in Revenue:

Increase in Revenue=1,890,000−1,800,000=90,000

Contribution Margin per Unit:

Contribution Margin per Unit=Selling Price−Variable Cost

=45−36=9

Total Additional Profit from Increased Sales:

Additional Profit= (42,000−40,000) × 9

=2,000×9=18,000

(b)Cost of Discounts:

Discounted Sales=1,890,000×70%

=1,323,000

Total Discount Cost=1,323,000×2%

=26,460

Calculate Reduction in Accounts Receivable

 QUESTION # 12
A firm is contemplating shortening its credit period from 40 to 30 days and believes that, as a
result of this change, its average collection period will decline from 45 to 36 days. Bad-debt
expenses are expected to decrease from 1.5% to 1% of sales. The firm is currently selling 12,000
units but believes that as a result of the proposed change, sales will decline to 10,000 units. The
sale price per unit is $56, and the variable cost per unit is $45. The firm has a required return on
equal-risk investments of 25%. Evaluate this decision, and make a recommendation to the firm.
(Note: Assume a 365-day year.)
Solution:
Given Data
 Current sales=12000 units
 New sales=10,000 units
 Selling price per unit= $56
 Variable cost per unit= $45
 Bad debt Reduction= 1.5% to 1% of sales
 ROI= 25%
 Collection period reduced from 45 to 36 days
(a)Loss Profit Due to Sales Decline:
Loss Profit= (12,000 – 10,000) × (56 – 45) = 22,000
(b) Loss Profit Due to Sales Decline:
Current Bad Debt= 1.5% × (12000 × 56) =10,080
New Bad Debt=1% × (10,000 × 56) = 5600
Savings= 10080 – 5600= 4480
(c)Reduction in A/R Investment:
45
Current A/R= × (12000 × 56 )=82,466
365
36
New A/R= × (10,000 × 56)=55,233
365
Reduction= 82,466 – 55233= 27,233
(d) Savings in Financing Decisions:
Savings=25% × 27,233= 6,808