Module 6 Working Capital Management

Question 1

Economic Order Quantity

Answer 1

• demand is constant
• the time it takes for deliveries to arriveis constant
• purchase costs per unit are constant

Question 2

Limitations to the EOQ model

Answer 2

• It assumes that materials are used at a constant rate
• It has limited use in dealing with materials whose use cannot be predicted
• It has limited use in dealing with materials whose prices fluctuate radically
• It depends upon historical data, which may not be an accurate guide to the future

Question 3

Re-order level

Answer 3

Re-order level = Lead time demand = lead time (days) x units used per day.

Question 4

Average stock level (with saftey stock)

Answer 4

Average stock level = safety stock + (order quantity / 2)

Question 5

Re-order level iff either lead time or demand is uncertain

Answer 5

Re-order level = maximum usage x maximum lead time

Question 6

Safety stock level if either lead time or demand is uncertain

Answer 6

Safety stock level = re-order level – (average usage x average lead time)

Question 7

Maximum stock level

Answer 7

Maximum stock level = re-order level – (minimum usage x minimum lead time) + re-order quantity

Question 8

Total stock cost

Answer 8

Total stock cost = Purchasing costs + Ordering costs + Holding costs

Question 9

Management of Trade Debtors

Answer 9

• Business does want to have some debtors
• Offering too much credit can result in high levels of bad debt

Question 10

Efficient management of trade debtors (7)

Answer 10

• Setting appropriate credit limits and periods for each customer;
• Choosing appropriate payment methods
• Monitoring the level of debtors
• Regularly reviewing the breakdown of debtors to identify potential bad debts, using an “an aged debtors report”;
• Communicating effectively and promptly with customers to minimise delays and errors in orders, invoices and deliveries;
• Taking appropriate and consistent action in the event of debtor default;
• Considering the use of factors to help finance the level of debtors

Question 11

Efficient management of trade creditors (5)

Answer 11

• Taking credit where offered, but not breaching the available credit
• Monitoring the level of creditors by the use of ratios such as the creditor days’ ratio
• Accepting discounts offered for early settlement
• Negotiating volume discounts and taking advantage of these where this minimises stock costs
• • Having robust and appropriate purchase ordering and goods inward procedures.

Question 12

Effectively manage the level of cash in the business

Answer 12

• identify periods where cash surpluses are available for investment or where there are deficits which require funding
• Agreeing appropriate bank financing
• Investments should be chosen to maximise the return available without taking excessive risks
• Any capital investment should be carefully planned