[FM/F9: Tài liệu ôn thi] Part A: Working Capital Management

Part A sẽ ôn lại 4 dạng bài tập quan trọng môn Financial Management (F9) với chủ đề Working Capital Management.

1. Tổng quan:

Topic	Question types	Questions
Working capital		MCQ	Case
	1. Inventory management	1,2	3
	2. Receivable collection		4,5
	3. Working capital funding strategies		6
Reference: BPP ACCA F9 - Financial Management StudyText Knowledge Base: [FM/F9: Tóm tắt kiến thức] Lesson 5: Quản lý vốn lưu động (Managing working capital)

2. Dạng bài tập chi tiết

Mức độ: Quan trọng

2.1. Dạng 1: Inventory management

Trắc Nghiệm

Câu 1: 

Sally Co has calculated the following in relation to its inventories.

Buffer inventory level	100 units
Reorder size	400 items
Fixed order costs	$35 per order
Cost of holding one item pa	$1.25 per year
Annual demand	15,000 items
Purchase price	$2 per item

What are the total inventory-related costs for a year (to the nearest whole $)?

$

Answer: $31,688

Guidance:

Remember:	Buffer inventory: the safety level of inventory held and constantly maintained to prevent out of stocks; This should be taken into account when calculating Inventory related costs = Purchase costs + Ordering costs + Costs of holding;
Purchase costs	= Purchase price per unit x Annual demand = 2 x 15,000	=	$ 30,000
Ordering costs	= Cost per order x Number of orders = 35 x 15,000/400	=	$ 1,312.5
Holding costs	= Average inventory x Cost of holding one item pa = ((400/2)+100) x 1.25	=	$ 375
Total		=	$31,687.5

Câu 2:

Green Co is a furniture manufacturer whose auditors have pointed out that its working capital position is far from satisfactory. The main problem is the high level of inventory which has led to the company building up a larger and larger bank overdraft. Managers at Green Co have been to numerous public lectures discussing various types of inventory control systems and technologies, but have felt that most of them are impractical.

(a) Indicate, by clicking in the relevant boxes, whether the following are or are not assumptions behind the traditional economic order quantity formula EOQ = √(2 × Co × D ÷ Ch).

Statement	Is an assumption	Is not an assumption
Constant demand
Zero lead time

1. 
   b) The production manager has established the following information about a major
   inventory item.

Purchase price per unit Annual demand Supplier’s delivery costs per order Chief buyer’s salary per annum Total number of orders placed per annum* Annual storage costs per unit Cost of capital *Relates to all product lines, not just this one.

$480 4,000 $10 $30,000 1,000 $2 10% per annum

What is the economic order quantity for this inventory item?     units                      

1. c) Assume that Green Co adopts the EOQ as its order quantity for that item of inventory
   and that it takes one week for an order to be delivered.
   How much inventory will Green Co have on hand when the order is placed? Assume there are 50 weeks in a year.
   units

(d) Which of the following statements referring to different types of inventory control systems and procedures are correct?

	1.	A just-in-time system implies relatively low reorder costs.
	2.	Periodic review means ordering inventory when it falls below the designated safety inventory level.
	3.	Use of the economic order quantity model means that holding and ordering costs should be the same
1 only			1 and 3 only	2 and 3 only	1, 2, and 3 only

Guidance

Part (a) and (b) apply straightforward knowledge of EOQ’s assumptions and formula calculation.

Part (c) requires you to find the level of inventory that must be sufficient to cover the lead-time of 1-week demand. This level is the re-order level.
Apply straightforward calculation of re-order level = Demand per weeks * lead time (weeks)

Part (d) 

With deliveries being made on a daily (or more frequent) basis, ordering costs need to be low compared to the benefits of holding inventory. Under the EOQ model, holding costs and ordering costs are balanced off, with the EOQ being at the point where these are equal to each other.

=> (3) is correct 

Periodic review means ordering inventory at a fixed and regular time interval. Inventory levels are reviewed at a fixed time. The inventory in hand is then made up to a predetermined level.
=> Statements (1) and (3) are correct

Tự Luận

Bulk discount

Approach: To decide whether the discount should be taken, it is necessary to compare the total annual costs at the EOQ and at the discounted quantity.

Step 1: Calculate the total annual costs at EOQ
Step 2: Calculate the total annual costs at discounted quantity
Step 3: Compare and conclude the bulk discount should be accepted if its related cost is lower than that of EOQ and vice sera.

Câu 3: KXP Co

KXP Co is an e-business which trades solely over the internet. KXP Co currently orders 15,000 units per month 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 $540,000. The supplier has offered a 2% discount for orders of Product Z of 30,000 units or more. Each order costs KXP Co $150 to place and the holding cost is 24 cents per unit per year. KXP Co has an overdraft facility charging interest of 6% per year.

Required

(b) Calculate whether the bulk purchase discount offered by the supplier is financially acceptable and comment on the assumptions made by your calculation.

Answer

Step 1: Total cost of current inventory policy
Please note: The amount ordered each time is given already which can be deemed as EOQ and apply the same approach.
Cost of materials = $540,000 per year
Annual ordering cost = 12 × 150 = $1,800 per year
Annual holding cost = 0.24 × (15,000/2) = $1,800 per year
Total cost of current inventory policy = 540,000 + 1,800 + 1,800 = $543,600 per year

Step 2: Cost of inventory policy after bulk purchase discount
Cost of materials after bulk purchase discount = 540,000 × 0.98 = $529,200 per year
Annual demand = 12 × 15,000 = 180,000 units per year
KXP Co 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 × 150 = $900 per year
Revised holding cost = 0.24 × (30,000/2) = $3,600 per year
Revised total cost of inventory policy = 529,200 + 900 + 3,600 = $533,700 per year

Step 3: Compare and conclude whether the bulk discount should be accepted 

Net benefit of taking bulk purchase discount = 543,600 – 533,700 = $9,900 per year
The bulk purchase discount looks to be financially acceptable. 

Evaluation of offer of bulk purchase discount 

However, this evaluation is based on a number of unrealistic assumptions. For example, the
ordering cost and the holding cost are assumed to be constant, which is unlikely to be true in reality. Annual demand is assumed to be constant, whereas in practice seasonal and other changes in demand are likely.

2.2. Dạng 2: Receivable collection

Tự luận

Early settlement discount

Approach method: Figure out the net benefit/cost of offering the discount

The pro-forma answer could be organised as follow:

Annual benefits ($)	x
Finance savings (if any) (W1)	x
Admin savings	x
Bad debts saved (*)	x
Annual costs	(x)
Incremental finance costs (if any) (W1)
Increase in admin costs (if any)	(x)
Discount cost	(x)
Net benefits/costs	x/(x)

Step 1: Calculate the preliminary calculations of existing and revised sales and resulted in receivable amounts (if needed for necessary cases; otherwise, start from step 2)
Step 2: Calculate the current finance cost, using current receivables amount and overdraft’s interest cost
Step 3: Calculate revised receivable days and revised receivables amount
Step 4: Calculate the revised finance cost and net it off with the current finance cost in Step 2 to get the finance savings using discount => end of working (W1)
Step 5: Calculate the net benefits/costs using the pro-forma format above and conclude whether the discount should be offered or not.

Câu 4: ULNAD

Ulnad Co has annual sales revenue of $6 million and all sales are on 30 days’ credit, although customers on average take ten days more than this to pay. The 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%. 

Ulnad Co 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 sales revenue. The discount is expected to be taken by 30% of customers, with the remaining customers taking an average of 60 days to pay.

Required
Evaluate whether the proposed changes in credit policy will increase the profitability of Ulnad Co

Answer

Step 1: Calculate the preliminary calculations of existing and revised credit sales

Current credit sales = $ 6m
Revised credit sales = 6m * 1.05 = $6.3 million

Step 2: Calculate the current finance cost, using current receivables amount and overdraft’s interest cost

Current average receivables days (collection period) = 30 + 10 = 40 days
Current accounts receivable = 6m × 40/365 = $657,534
Current finance costs = $657,534 * 7% = $46,027

Step 3: Calculate revised receivable days and revised receivables amount

Revised average receivables days = (0.3 × 15) + (0.7 × 60) = 46.5 days
Revised receivables amount = 6.3m * 46.5/365 = $802,603

Step 4: Calculate the revised finance cost and compare it with current one to find the finance savings or incremental costs under new situation 

Revised finance costs = $802,603 * 7% = $56,182.
Incremental finance costs = $64,208 - $46,027 = $10,155

Step 5: Calculate the net benefits/costs using the pro-forma format above and conclude whether the discount should be offered or not.

Annual benefits ($)	180,000
Admin savings	0
Contribution on extra sales (60% * (6.3m-6m))	180,000
Annual costs	(70,005)
Increase in financing cost (W1)	(10,155)
Incremental costs	(31,500)
Discount cost (6.3m × 0.015 × 0.3)	(28,350)
Net benefits/costs	109,995

The proposed policy change will increase the profitability of Ulnad Co.

Note: Please visit the other solution approach for Ulnad Co case in Kaplan kit.

Factoring: Recourse and Non-recourse

Approach method: Figure out the net benefit/cost by comparing the benefits and costs of using the factor.
The pro-forma answer could be organized as follow:

Annual benefits ($)	x
Finance savings on reduced receivables (W1)	x
Admin savings	x
Bad debts saved (*)	x
Annual costs	(x)
Increase in finance costs (if any)	(x)
Factor fee	(x)
Net benefits/costs	x/(x)

Normally, other information, except the financial savings on reduced receivables, is given in the scenario. The following steps are used in workings (W1) where the finance costs of the current situation will be compared with that of the revised situation (factor adopted).

Step 1: Calculate the finance cost under the current situation, using current receivables amount and overdraft’s interest cost
Step 2: Calculate the revised receivable amount when using factor
Step 3: Calculate the revised finance costs relating to receivables using factor
Step 4: Compare the revised finance costs in Step 3 with the current finance costs in Step 1 to get the finance saving on reduced receivables. => end of W1
Step 5: Calculate the net benefits/costs using the pro-forma format above and conclude whether the factoring agreement should be accepted or not.

(*) Bad debt amount will change between non-recourse and recourse factoring.
Recourse factoring provides no protection against bad debt while non-recourse factoring offer full protection for the company against all bad debt. Hence, the factoring agent will charge higher price for a non-recourse factoring agreement. 

Câu 5: Widnor Co (12 mins) 

The finance director of Widnor Co has been looking to improve the company's working capital management. Widnor Co has revenue from credit sales of $26,750,000 per year and, although
its terms of trade require all credit customers to settle outstanding invoices within 40 days, on
average customers have been taking longer. Approximately 1% of credit sales turn into bad debts
which are not recovered. Trade receivables currently stand at $4,458,000 and Widnor Co has a cost of short-term finance of 5% per year.

The finance director is considering a proposal from a factoring company, Nokfe Co, which was
invited to tender to manage the sales ledger of Widnor Co on a with-recourse basis. Nokfe Co
believes that it can use its expertise to reduce average trade receivables days to 35 days, while
cutting bad debts by 70% and reducing administration costs by $50,000 per year. A condition of
the factoring agreement is that the company would also advance Widnor Co 80% of the value of
invoices raised at an interest rate of 7% per year. Nokfe Co would charge an annual fee of 0.75%
of credit sales. Assume that there are 360 days in each year.

Require

Advise whether the factor's offer is financially acceptable to Widnor Co. (7 marks)

Answer

The factor's offer will be financially acceptable to Widnor Co if it results in a net benefit
rather than a net cost.

Step 1: Calculate the current finance cost, using current receivables amount and overdraft’s interest cost
Current receivables = 4,458,000
Current finance costs = 4,458,000 * 5% = $222,900

Step 2: Calculate the revised receivable amount when using factor
Revised receivable days = 35 days
Revised receivables = 26.75m * 35/360 = $2,600,694

Step 3: Calculate the revised finance costs relating to receivables using factor
Finance costs on receivables using factor = 2,600,694 * 80% * 7% = $145,639
Finance costs on receivables using overdraft  = 2,600,694 * 20% * 5% = $26,007
Revised finance costs = 145,639 + 26,007 = $171,646
Step 4: Compare the revised finance costs in step 3 with the current finance costs in step 1 to get the finance saving on reduced receivables.
Finance savings = $222,900 - $171,646 = $51,254

Step 5: Calculate the net benefits/costs using the pro-forma format above and conclude whether the factoring agreement should be accepted or not.

Annual benefits ($)	288,504
Finance savings on reduced receivables (W1)	51,254
Admin savings	50,000
Bad debts saved (26.75m * 1% * 70*)	187,250
Annual costs	(200,625)
Factor fee	(200,625)
Net benefits	87,879

The factor's offer is therefore financially acceptable
Note: Please visit another approach for Widnor case’s solution in BPP Kit. 

3.3. Dạng 3: Working capital funding strategies

This knowledge section is often tested under a scenario and requires students to present the answer under paragraph writing layout. 

Câu 6: HGR
The following financial information relates to HGR Co:
Statement of financial position at the current date (extracts)

	$’000	$’000	$’000
NCA			48,965
Current assets
Inventory		8,160
Accounts receivables		8,775
		16,935
CL
Overdraft	3,800
Accounts payables	10,200
		14,000
Net CA			2,935

Current cash flow forecasts:

	Month 1	Month 2	Month 3
Cash operating receipts ($’000)	4,220	4,350	3,808
Cash operating payments ($’000)	3,950	4,100	3,750
Six-monthly interest on traded bonds ($’000)		200
Capital investment ($’000)			2,000

The finance director has completed a review of accounts receivable management and has
proposed staff training and operating procedure improvements, which he believes will
reduce accounts receivable days to the average sector value of 53 days. This reduction
would take six months to achieve from the current date, with an equal reduction in each
month. He has also proposed changes to inventory management methods, which he hopes
will reduce inventory days by two days per month each month over a three-month period
from the current date. He does not expect any change in the current level of accounts
payable.
HGR Co has an overdraft limit of $4,000,000. Overdraft interest is payable at an annual rate
of 6.17% per year, with payments being made each month based on the opening balance at
the start of that month. Credit sales for the year to the current date were $49,275,000 and
cost of sales was $37,230,000. These levels of credit sales and cost of sales are expected to
be maintained in the coming year. Assume that there are 365 working days in each year.

Required

Discuss the working capital financing strategy of HGR Co.

Guidance

There are 02 factors under consideration for this theory question: Writing skills and Technical skills.

Writing skills

Sequence of a discussion answer: Thesis and topic sentence in Introduction => Topic sentences in each paragraph and Supporting sentences in Body Part => Link to the scenario were relevant and conclusion.

Technical skills

The answer must fulfill all the aspects of financing strategies on working capital: Funding sources, choices of permanent vs fluctuating current assets, and funding strategies.

For each aspect, key points to demonstrate include:

• Simple definition
• Compare & contrast between sub-elements in each aspect
• Finally, calculations from scenario were relevant to support the conclusion of which strategy the company is adopting.

Answer

When considering the financing of working capital, it is useful to divide current assets into fluctuating current assets and permanent current assets. Fluctuating current assets represent changes in the level of current assets due to the unpredictability of business activity. Permanent current assets represent the core level of investment in current assets needed to support a given level of revenue or business activity. As revenue or level of business activity increases, the level of permanent current assets will also increase. This relationship can be measured by the ratio of revenue to net current assets.

The financing choice as far as working capital is concerned is between short-term and long-term finance. Short-term finance is more flexible than long-term finance: an overdraft, for example, is used by a business organization as the need arises and variable interest is charged on the outstanding balance. Short-term finance is also riskier than long-term finance: an overdraft facility may be withdrawn, or a short-term loan may be renewed on less favorable terms. In terms of cost, the term structure of interest rates suggests that short-term debt finance has a lower cost than long-term debt finance.
The matching principle suggests that long-term finance should be used for long-term investment. Applying this principle to working capital financing, long-term finance should be matched with permanent current assets and non-current assets. 

A financing policy with this objective is called a ‘matching policy’. HGR Co is not using this financing policy, since of the $16,935,000 of current assets, $14,000,000 or 83% is financed from short-term sources (overdraft and trade payables), and only $2,935,000 or 17% is financed from a long-term source, in this case, equity finance (shareholders’ funds) or traded bonds.