Working Capital

Question 1

Claw is preparing its cash flow forecast for the next quarter.

Which of the following items should be excluded from the calculations?

A - The receipt of a bank loan that has been raised for the purpose of investment in a new rolling mill
B - Depreciation of the new rolling mill
C - A tax payment that is due to be made, but which relates to profits earned in a previous accounting period
D - Disposal proceeds from the sale of the old rolling mill

Answer 1

B - Depreciation of the new rolling mill

This is a non-cash item and should therefore be excluded

Question 2

A cash budget has been drawn up as follows:

January:

Receipts
Credit sales: 10,000 (JAN), 11,000 (FEB), 12,500 (March)
Cash sales: 5,000 (J), 4,500 (F), 6,000 (M)

Payments:
Suppliers: 6,500 (J), 4,200 (F), 7,800 (M)
Wages: 2,300 (J), 2,300 (F), 3,000 (M)
Overheads: 1,500 (J), 1,750 (F), 1,900 (M)
Opening cash: 500 (JAN)

The closing cash balance for March is budgeted to be:
A - £5,800
B - £12,450
C - £17,750
D - £18,250

Answer 2

D - £18,250

January:
Receipts
Credit sales: 10,000
Cash sales: 5,000
= 15,000

Payments
Suppliers: 6,500
Wages: 2,300
Overheads: 1,500
= 10,300

Opening cash: 500
Net cash receipts: 4,700 (15,000 - 10,300)
Closing cash = 5,200

February:
Receipts:
Credit sales: 11,000
Cash sales: 4,500
=15,500

Payments
Suppliers: 4,200
Wages: 2,300
Overheads: 1,750
= 8,250

Opening cash: 5,200
Net cash receipts: 7,250
Closing cash = 12,450

March:
Receipts
Credit sales: 12,500
Cash sales: 6,000
= 18,500

Payments
Suppliers: 7,800
Wages: 3,000
Overheads: 1,900
= 12,700

Opening cash: 12,450
Net cash receipts: 5,800
Closing cash = 18,250

Question 3

A machine that was bought in January 20X1 for £44,000 and has been depreciated by £8,000 per year, is expected to be sold in December 20X3 for £17,600.

What is the net cash inflow or (outflow) that will appear in the cash budget for December 20X3?
A - £9,000 inflow
B - £15,200 inflow
C - £17,600 inflow
D - £17,600 outflow

Answer 3

C - £17,600 inflow

Depreciation and profits and losses on sales are accounting entries only. The only amount that will
appear in the cash budget is the receipt of the £17,600 sale proceeds

Question 4

Jason is preparing a cash budget for July. His actual credit sales are:

April 40,000
May 30,000
June 20,000
July 25,000

His recent debt collection experience has been as follows:
Current month’s sales 20%
Prior month’s sales 60%
Sales two months prior 10%
Cash discounts taken 5%
Bad debts 5%

How much should Jason budget to collect from customers during July?
A - £19,750
B - £20,000
C - £22,000
D - £26,000

Answer 4

B - £20,000

July receipts
(Ignore the discounts: the percentages add to 100 so discounts have already been accounted for)
20% July sales = £5,000
60% June sales = £12,000
10% May sales = £3,000
Total = £20,000

Question 5

Lotsa plc has budgeted that sales will be £101,500 in January 20X2, £580,500 in February, £215,000 in March and £320,500 in April.

Half of sales will be credit sales. 80% of customers are expected to pay in the month after sale, 15%
in the second month after sale, while the remaining 5% are expected to be bad debts.

Customers who pay in the month after sale can claim a 4% early settlement discount

What level of sales receipts should be shown in the cash budget for March 20X2 (to the nearest £)?
A - £338,025
B - £347,313
C - £568,550
D - £587,125

Answer 5

A - £338,025

Half-receipts: £107,500
80% x (580,500/2) less 4% credit discount so x 96% = £222,912
15% x (101,500/2) = £7,612.50&raquo_space; 7,613
—
338,025

Question 6

A company has a two-month receivables cycle. It receives in cash 45% of the total gross sales value in the month of invoicing.

Bad debts are 7% of total gross sales value and there is a 10% discount for settling accounts within
30 days.

What percentage of the first month’s sales will be received as cash in the second month?
A - 38%
B - 43%
C - 48%
D - 58%

Answer 6

Suppose the total gross invoiced sales is £100.
Cash received 45%.
But these customers have taken a 10% discount before paying, hence the gross value of bills settled
is 45/0.9 = £50
Bad debts 7% = £7
Balancing figure ie, received in month two = £43
Total = £100

Question 7

From the customer collection records of Low Ltd, it is possible to determine that 60% of invoices are paid in the month after sale, 30% in the second month after sale and 5% in the third month after sale.
Invoices are raised on the last day of each month and 5% become bad debts.

Customers who settle in the month after sale are entitled to a 4% settlement discount. Budgeted
credit sales in January 20X6 are £221,500, in February £332,000, in March £175,000 and in April
£384,000

What is the amount budgeted to be received in April from credit sales (to the nearest £)?

A - £211,475
B - £215,675
C - £290,284
D - £299,500

Answer 7

A - £211,475

April:
60% x 175,000 x 96% (settlement discount) = 100,800
30% x 332,000 = 99,600
5% x 221,500 = 11,075
—
211,475

Question 8

A company anticipates that 10,000 units of product Z will be sold during August.

Each unit of Z requires two litres of raw material W.
Actual inventories as at 1 August and budgeted inventories as at 31 August are:

Product Z (units): 14,000 (1 Aug), 15,000 (31 Aug)
Raw materials W (litres): 20,000 (1 Aug), 15,000 (31 Aug)

A litre of W costs £1.50. If the company pays for all purchases in the month of acquisition, what is the
payment for August purchases of W?

A - £17,000
B - £25,500
C - £33,000
D - £34,500

Answer 8

B - £25,500

Production of Z: (units)
Sales requirement 10,000
Closing inventory 15,000
—
25,000
Opening inventory (14,000)
Budgeted production 11,000

Purchases of W: (litres)
Purchase requirement (11,000 units × 2 litres) 22,000
Closing inventory 15,000
—-
37,000
Opening inventory (20,000)
—
17,000
Cost at £1.50 per litre £25,500

Question 9

Sam is a trading company that holds no inventories. Each month the following relationships hold:
Gross profit 40% of sales
Closing trade payables 30% of cost of sales
Sales are budgeted to be £48,500 in April and £36,500 in May.

How much cash is budgeted to be paid in May to suppliers?
A - £19,740
B - £21,900
C - £23,340
D - £24,060

Answer 9

D - £24,060

April cost of sales = 60% × £48,500 = £29,100
Closing payables balance for
April = £29,100 × 30% = £8,730
May cost of sales = 60% × £36,500 = £21,900
Closing payables balance for
May = £21,900 × 30% = £6,570
Reduction in payables balance
in May = £2,160
Cost of sales for May = £21,900
Supplier Payments in May
= £24,060

The reduction in the payables balance should have been added, since this means that higher payments
were made to suppliers to reduce the balance owed

Question 10

The budgeted sales for the first six months of Bendy Ltd’s business are:

January 60,000
February 75,000
March 84,000
April 90,000
May 90,000
June 87,000

Bendy Ltd (Bendy) wishes to maintain inventory levels, as at the end of each month, to cover sales for
the following three months. Purchases are made at the beginning of each month, and suppliers are
to be paid after two months. Bendy will operate a 40% mark-up on costs.

The payment to be made to suppliers in May is (to the nearest £)
A - £52,200
B - £62,143
C - £64,286
D - £87,000

Answer 10

B - £62,143

Bendy will pay for March’s purchases in May.
In March, he will top up inventories by those required for June’s sales.
Cost of goods sold in June = £87,000 × 100/(100 + 40) = £62,143

The more traditional approach to calculating this would be:
March opening inventory =
(84,000 + 90,000 + 90,000) ×
100/140 = (£188,571)
March closing inventory =
(90,000 + 90,000 + 87,000) ×
100/140 = £190,714
March cost of sales = 84,000 × 100/140 = £60,000
£62,143

Question 11

The following is an extract from an entity’s budget for next month

Sales £520,000
Gross profit on sales 30%
Increase in trade payables over the month £15,000
Decrease in cost of inventory held over the month £22,000

The budgeted payment to trade payables is:
A - £327,000
B - £357,000
C - £371,000
D - £401,000

Answer 11

A - £327,000

Cost of sales for month = £520,000 × 70% 364,000
Increase in trade payables (15,000)
Decrease in inventory (22,000)
Budgeted payment to trade payables 327,000

Question 12

A company is preparing the budget for a product, and the following data has been provided:

Planned sales (units)
Month 1: 2,000
Month 2: 2,200
Month 3: 2,500
Month 4: 2,600

Closing inventory in each month must be 50% of the next month’s sales. Suppliers are paid in the
month following purchase. The standard cost of materials is £4 per unit

What is the budgeted payment to suppliers in Month 3?

A - £8,200
B - £9,400
C - £10,000
D - £10,200

Answer 12

B - £9,400

Month 1: (units)
Sales: 2,000
Closing inventory: 1,100
Opening inventory: (1,000)
Purchases: 2,100
Payments (£)

Month 2:
Sales: 2,200
Closing inventory: 1,250
Opening inventory: (1,100)
Purchases: 2,350
Payments (£) 2,100 x 4 = 8,400

Month 3:
Sales: 2,500
Closing inventory: 1,300
Opening inventory: (1,250)
Purchases: 2,550
Payments (£) 2,350 (previous month) x 4 = 9,400

Question 13

Each unit of product Zeta requires 3 kg of raw material and four direct labour hours. Material costs £2 per kg and the direct labour rate is £7 per hour.

The production budget for Zeta for April to June is as follows:

Production units: 7,800 (April), 8,400 (May), 8,200 (June)

Raw material opening inventories are budgeted as follows::
3,800 (April), 4,200 (May), 4,100 (June)

The closing inventory budgeted for June is 3,900 kg.
Material purchases are paid for in the month following purchase.

The figure to be included in the cash budget for June in respect of payments for purchases is
A - £25,100
B - £48,800
C - £50,200
D - £50,600

Wages are paid 75% in the month of production and 25% in the following month

The figures to be included in the cash budget for May in respect of wages is
E - £222,600
F - £231,000
G - £233.800
H - £235,200

Answer 13

4,200 / 3 = 1,400
1,400 x (3 x 2) = £8,400 material cost

Labour hours: 4 x £7 per unit = £28
28 x 1,400 = £39,200

C - £50,200

Payments in June will be in respect of May purchases.

Production requirements (8,400 units × 3 kg) 25,200 kg
Closing inventory 4,100 kg
= 29,300 kg

Less opening inventory (4,200) kg
Purchase budget 25,100 kg
25,100 kg × £2 per kg = payment for purchases in June = £50,200

F - £231,000

75% × May wages cost = 75% × 8,400 × £7 × 4 hours 176,400
25% × April wages cost = 25% × 7,800 × £7 × 4 hours 54,600
Wage payments for May = 176,400 + 54,600 = 231,000

Question 14

Aaron Products is considering the implementation of a revised receivables policy, which will result in an increase in the average collection period from the current 60 days to 90 days. This is expected to lead to a 20% increase in annual sales revenue, currently £960,000, resulting in additional inventories and trade payables of £30,000 and £15,000 respectively. It is expected that all customers will take advantage of the extended credit period.

The net increase in working capital investment that would result from the change in policy, assuming
a 360-day year, is

A - £31,000
B - £95,000
C - £113,000
D - £143,000

Answer 14

D - £143,000

Average receivables after change in policy 90/360 × £960,000 × 120% = 288,000
Less: current average receivables 60/360 × £960,000 = (160,000)
Increase in receivables = 128,000

Increase in inventories + 30,000
Increase in payables (15,000)
———-
Net increase in working capital investment = 143,000

Question 15

In order to improve operational cash flows, indicate whether a business needs to increase or decrease each of the following:

Receivables:
A - Increase
B - Decrease

Inventory
C - Increase
D - Decrease

The credit period from trade suppliers:
E - Increase
F - Decrease

Answer 15

B - Decrease receivables
D - Decrease inventory
E - Increase the credit period taken from suppliers

Question 16

Which two of the following actions would be appropriate if the cash budget identified a short-term cash deficit?

A - Issue shares
B - Pay suppliers early
C - Arrange an overdraft
D - Implement better credit control procedures
E - Replace non-current assets

Answer 16

C - Arrange an overdraft
D - Implement better credit control procedures

Arranging short-term finance in the form of an overdraft and encouraging receivables to pay sooner
will alleviate the short-term cash deficit problem

Question 17

A telephone business has annual sales of £1.1 million and a gross profit margin of 10%. It is currently experiencing short-term cash flow difficulties and intends to delay its payments to trade suppliers by one month

To the nearest £, the amount by which the cash balance will benefit in the short term from this
change in policy, assuming sales are spread evenly over the year, and inventory levels remain
constant throughout, is:
A - £82,500
B - £83,333
C - £91,667
D - £100,833

Answer 17

A - £82,500

Gross profit = 10% sales, and cost of sales = 90% sales
Annual cost of sales = 90% ×£1.1m = £990,000
As inventories remain constant, this is also the annual purchase cost, which is spread evenly over the
year.
Thus one month’s purchases = £990,000/12 = £82,500.
This is the value of one month’s extra trade credit, ie, the cash benefit to be derived from delaying
payment by one month

Question 18

A company’s cash budget highlights a short-term surplus in the near future

Which two of the following actions would not be appropriate to make use of the surplus?
A - Increase inventories and receivables to improve customer service
B - Buy back the company’s shares
C - Increase payables by delaying payments to suppliers
D - Invest in a short-term deposit account

Answer 18

B - Buy back the company’s shares
C - Increase payables by delaying payments to suppliers

Buying back the company’s shares would be a suitable use of a long-term surplus (but not short-
term), by returning surplus cash to the shareholders.

Increasing payables would increase the surplus still further because additional credit would be taken
from suppliers

Question 19

A company has annual sales of £3 million and its gross profit is 60% of sales. Inventory turnover is 60 days, customers take an average of 35 days to pay and the company pays its suppliers after 25 days

Defining working capital as average inventories plus average receivables minus average trade
payables and using a 365-day year for your calculations, to the nearest £1,000, the company’s
working capital will be

A - £280,000
B - £403,000
C - £567,000
D - £699,000

Answer 19

B - £403,000

Inventories 60/365 × 40% of £3m = 197,260
Receivables 35/365 × £3m = 287,671
———–
484,931

Trade payables 25/365 × 40% of £3m = (82,192)
402,739&raquo_space;> 403,000

Question 20

The following information relates to a business:
Debt collection period 11 weeks
Raw material inventory holding period 3 weeks
Suppliers’ credit period 6 weeks
Production period 2 weeks
Finished goods inventory holding period 7 weeks

What is the working capital (operating) cycle of the business?
A - 6 weeks
B - 7 weeks
C - 17 weeks
D - 29 weeks

Answer 20

C - 17 weeks

Raw materials 3
Payables (6)
Production 2
Finished goods 7
Receivables 11
—–
17

Question 21

Inventories: Raw materials 250,000
Work in progress 115,000
Finished goods 186,000
Purchases 1,070,000
Cost of goods sold 1,458,000
Sales 1,636,000
Receivables 345,000
Trade payables 162,000

Using the table above and a 365-day year, calculate the length of the working capital cycle
(operating cycle)

A - 174 days
B - 182 days
C - 193 days
D - 293 days

Answer 21

B - 182 days

Raw material inventory turnover (250,000/1,070,000 × 365 days) = 85.3 days
Less payables: average payment period (162,000/1,070,000 × 365) = (55.3) days
—
30 days

Production cycle (WIP turnover) (115,000/1,458,000 × 365) = 28.8 days
Finished goods inventory turnover (186,000/1,458,000 × 365) = 46.6 days
Debt collection period (345,000/1,636,000 × 365) = 77.0 days
Full operating cycle = 182.4 days

Question 22

Which two of the following might be associated with a lengthening cash cycle?
A - Lower net operating cash inflow
B - Lower investment in working capital
C - Taking longer to pay trade suppliers
D - Slower inventory turnover
E - Higher net asset turnover

Answer 22

A - Lower net operating cash inflow
D - Slower inventory turnover

When the cash cycle lengthens, there will be a slow-down in operating cash inflows, and net cash
inflow will be lower. The reasons for a longer cash cycle could be a slower inventory turnover, a
lengthening of the average credit period taken by customers and/or paying suppliers sooner.

Question 23

The following information is available for a wholesale business for the latest year

Opening balance:
Receivables: 200,000
Inventory: 120,000
Payables: 170,000

Closing balance:
Receivables: 220,000
Inventory: 220,000
Payables: 130,000

The cost of goods sold during the year was £2 million and the company earns a margin of 20% of
sales. Half of all sales are credit sales and the remainder are cash sales

Using a 365-day year in your calculations, what is the length of the cash operating cycle in respect of
credit sales?

A - 65 days
B - 66 days
C - 68 days
D - 118 days

Answer 23

B - 66 days

Average inventory = £170,000
Inventory period = (170/2,000) × 365 = 31.03 days

Sales value = £2,000,000 × 100/80 = £2,500,000
Credit sales = £1,250,000
Average receivables = £210,000
Receivables period = (210/1,250) × 365 = 61.32 days

Purchases
= cost of goods sold + inventory increase
= £2,000,000 + £100,000
= £2,100,000

Average payables = £150,000
Payables period = (150/2,100) × 365 = (26.07) days

Cash operating cycle = 66.28 days

Question 24

A company has liquidity ratio (receivables divided by payables and bank overdraft) equal to 0.5. The directors believe that the company has to reduce its bank overdraft and have agreed to alter the
company’s credit terms to customers from two months to one month

What would be the effects on the company’s cash operating cycle and liquidity ratio if this change
were to be achieved?

A - Cash operating cycle: Decrease; Liquidity ratio: Decrease
B - Cash operating cycle: Decrease; Liquidity ratio: No change
C - Cash operating cycle: Decrease; Liquidity ratio: Increase
D - Cash operating cycle: Increase; Liquidity ratio: Increase

Answer 24

A - Cash operating cycle: Decrease; Liquidity ratio: Decrease

The reduction in the amount of time taken for customers to pay their bills would reduce the cash
operating cycle.

The reduction in receivables and in the overdraft mean that the numerator and denominator of the
liquidity ratio would both reduce by the same amount. Therefore, the ratio would decrease.

Question 25

£m

Assets:
Non-current assets 10.5
Inventories 4.2
Receivables 2.8
Cash in hand 0.3
7.3
—-
17.8

Liabilities:
Trade payables 2.6
Other short-term payables 0.8
Loan repayable in five years 6.5
—
9.9

From the extracts from a draft balance sheet above, calculate the quick (liquidity) ratio
A - 0.31
B - 0.91
C -1.80
D - 2.15

Answer 25

B - 0.91

Quick ratio = Current assets excluding inventories/current liabilities
= (2.8 + 0.3)/(2.6 + 0.8)
= 0.91

Question 26

A company’s liquidity (quick or acid test) ratio, which includes receivables, cash and payables, is 0.5

Consideration is being given to two changes:
Proposal 1: Offer a 2% cash discount to customers for early settlement.
Proposal 2: Delay payment to all suppliers

All other things being equal, what will be the effects of the proposed change on the liquidity ratio?

Proposal 1:
A - Increase
B - Decrease
C - No change

Proposal 2:
D - Increase
E - Decrease
F - No change

Answer 26

B - Decrease

Let receivables = 100
Cash = 50
Therefore payables = 300

Receivables = 0
Cash = 50 + 98 (100 less 2%) = 148
Therefore current ratio = 148/300
= 0.493

Proposal 2: Delay payment to all suppliers
D - Increase
Cash and payables will both rise at same rate, say, by 50.
Therefore current ratio = 200/350
= 0.57

Question 27

If an increase in inventory levels is funded by an increase in the bank overdraft, what will be the effect on the quick (liquidity) ratio?

A - Increase
B - Decrease
C - Remain the same
D - Increase, decrease or remain the same depending on the initial size of the quick ratio

Answer 27

B - Decrease

The quick (liquidity) ratio is current assets (excluding inventory) divided by current liabilities. As inventory is excluded from the ratio any change in inventory levels would have no effect on the ratio unless either other current assets (such as cash at bank) or current liabilities are also affected. If inventory levels are financed by an increase in the bank overdraft then the denominator of the ratio would increase, reducing the ratio itself. This will always be the case regardless of the relative values of current assets and current liabilities.

It is worth noting that if inventory levels are increased by reducing the cash at bank balance then the
quick ratio would again decrease.

Question 28

A company has a current ratio greater than 1:1 and a quick (liquidity) ratio less than 1:1

If the company uses cash to reduce trade payables, how will these payments affect each of the
ratios?

Current ratio:
A - Increase
B - Decrease
C - No change

Quick (liquidity) ratio:
D - Increase
E - Decrease
F - No change

Answer 28

A - Increase
E - Decrease

The quick ratio is current assets (excluding inventory) divided by current liabilities. If cash is used to reduce trade payables then both the numerator and denominator will reduce. As the quick ratio is less than 1:1 the denominator is larger than the numerator. This means that the same absolute change to the numerator would represent a smaller proportionate change to the denominator than the numerator, thereby reducing the ratio.

Question 29

A retailing company’s current assets and current liabilities consist of inventory at cost £2,100, receivables, cash and trade payables. Its financial ratios include the following:

Quick (liquidity) ratio = 2:1
Rate of inventory turnover = 10 times p.a.
Gross profit margin = 30%
Receivables collection period = 1 month
Payables payment period = 1.6 months
The opening inventory, receivables and payables balances are the same as the closing balances.

The closing cash in hand balance will be:
A - £3,100
B - £2,170
C - £1,000
D - £100

Answer 29

A - £3,100

The inventory value is £2,100. The rate of inventory turnover is 10 times pa, therefore the annual cost
of sales is £21,000 (we are told opening inventory equals closing inventory). The gross profit margin is 30% which means annual sales are £21,000/0.7 = £30,000.

The receivables collection period is 1 month, which means closing receivables are £30,000/12 = £2,500.
The payables payment period is 1.6 months, which means closing payables are £21,000/12 × 1.6 = £2,800.
The quick ratio is 2:1 which means current assets (excluding inventory) are £2,800 × 2 = £5,600.

As receivables are £2,500 the cash balance must be (£5,600 – £2,500) = £3,100

Question 30

Fenton Ltd’s projected revenue for 20X1 is £350,000. It is forecast that 12% of sales will occur in January and remaining sales will be equally spread among the other 11 months. All sales are on credit. Receivables accounts are settled 50% in the month of sale, 45% in the following month, and 5% are written off as bad debts after two months.

The budgeted cash collections for March are:
A - 24,500
B - 26,600
C - 28,000
D - 32,900

Answer 30

B - 26,600

January sales are £350,000 × 12% = £42,000. Sales in each of the other months are (£350,000 –
£42,000)/11 = £28,000.
March cash collections will be:
50% of March sales = £28,000 × 50% = £14,000
45% of February sales = £28,000 × 45% = £12,600
Total = (£14,000 + £12,600) = £26,600

Question 31

A retail company extracts the following information from its accounts at 30 June 20X6:
Average inventory 490,000
Average receivables 610,000
Average payables 340,000
Cost of sales 4,500,000
Purchases 4,660,000
Gross profit margin 32%

The number of days in the company’s cash operating cycle is:
A - 34 days
B - 44 days
C - 47 days
D - 51 days

Answer 31

C - 47 days

Average inventory/COS x 365 = Inventory days
490,000/4,500,000 x 365 = 39.7 days

Receivables days:
Average receivables/(COS/profit margin) x 365
610,000/(4,500,000/0.68) x365 = 33.6 days

Less: payables days
Average payables/purchases x 365
340,000/4,660,000 x 365 = 26.6 days

The company’s cash operating cycle is calculated as:
(Inventory days + receivables days – payables days)

The answer is therefore (39.7 + 33.6 – 26.6) days = 46.7 days (rounded to 47).

Question 32

Fraser Ltd manufactures leather bags. The company buys raw materials from suppliers that allow the company 2.5 months credit. The raw materials remain in inventory for 1 month and it takes Fraser Ltd
2 months to produce the goods, which are sold immediately production is completed. Customers
take an average 1.5 months to pay.

Fraser Ltd’s cash operating cycle is:
A - 1 month
B - 1.5 months
C - 2 months
D - 6 months

Answer 32

C - 2 months

Months:
The average time the raw materials are in inventory 1.0
Less the time taken to pay suppliers (2.5)
Time taken to produce the goods 2.0
Time taken by customers to pay for the goods 1.5
Total 2.0

Question 33

Trant plc has a two-stage trading process
Stage 1: buy a large quantity of goods on credit
Stage 2: immediately sell them on credit at a profit

Which of the following will increase after Stage 1?
A - Receivables and inventory
B - Current assets and non-current assets
C - Payables and cash
D - Current assets and current liabilities

Answer 33

D - Current assets and current liabilities

The purchase of goods increases inventory (current assets) while the taking of credit in respect of the purchase increases payables (current liabilities).

Question 34

Merlion plc is an international company based in Malaysia. It manufactures and sells items for a wide variety of outdoor leisure pursuits including wind surfing, camping and mountain biking. A summary of the ratios provided by the chief accountant is as follows:

Receivables collection period:
20X4: 49 days
20X5: 38 days
20X6: 35 days

Payables Payment period:
20X4: 51 days
20X5: 35 days
20X6: 30 days

Inventory turnover period:
20X4: 23 days
20X5: 25 days
20X6: 29 days

What are the figures for Merlion plc’s cash operating cycle for each of the three years?
Cash operating cycle in 20X4
A - 21 days
B - 28 days
C - 34 days

Cash operating cycle in 20X5
D - 21 days
E - 28 days
F - 34 days

Cash operating cycle in 20X6
G - 21 days
H - 28 days
I - 34 days

Answer 34

A - 21 days
E - 28 days#
I - 34 days

Question 35

Shrier plc is trying to decide on its optimal level of current assets. The company’s management face a trade-off between:
A - profitability and risk
B - liquidity and risk
C - equity and debt
D - short-term and long-term borrowing

Answer 35

A - profitability and risk

All businesses face a trade-off between being profitable and being liquid. Less liquidity may yield greater profitability, but less liquidity equals greater risk (A).

Question 36

If a business is suffering from liquidity problems, the aim must be to reduce the length of the cash operating cycle

Which three of the following actions would achieve this?
A - Reducing the credit period extended to receivables
B - Reducing the payables payment period
C - Extending the period of credit taken from suppliers
D - Reducing the production period
E - Extending the inventory holding period

Answer 36

A - Reducing the credit period extended to receivables
C - Extending the period of credit taken from suppliers
D - Reducing the production period

A business suffering from liquidity problems might consider:
- reducing the production period – not easy to do but it might be worth investigating different*
machinery or different working methods.
- reducing the credit period extended to receivables.*
- extending the period of credit taken from suppliers.*
The business would not want pay its payables quicker (B) or to hold inventory for longer (E)

Question 37

Albert’s Autos is a small garage providing car servicing. Business is good, there is a steady stream of income from repeat customers and breakdown recoveries. There are no significant cash reserves and
there is no need for an overdraft. Now the organisation that passes on most of the breakdown
recovery work offers Albert a contract to supply recovery services over a 50-mile radius. It is seeking
60 days credit rather than Albert’s usual 30 days. Albert is keen but has been warned to look for signs
of overtrading.

Which two of the following are most likely to be symptoms of overtrading?
A - A lengthening of the cash operating cycle
B - A rapid reduction in sales
C - Increase in the level of the current ratio
D - A rapid increase in sales
E - A shortening of the cash operating cycle

Answer 37

A - A lengthening of the cash operating cycle
D - A rapid increase in sales

There is no reason to believe that the current ratio would increase (C) – there could be a rapid increase in current assets (particularly receivables) but this would be often more than matched by a commensurate increase in current liabilities (payables and bank overdraft). A lengthening cash operating cycle (A) and a rapid increase in sales (D) are the classic signs of overtrading

Question 38

Apart from the actual cost of buying inventory, there are other inventory costs to consider.

Which two of the following are inventory holding costs?
A - Clerical and administrative expenses
B - Insurance
C - Opportunity cost of capital tied up
D - Production stoppages due to lack of raw materials
E - The cost of inventory packaging materials

Answer 38

B - Insurance
C - Opportunity cost of capital tied up

Holding costs include insurance (B) and the opportunity cost of capital tied up (C). (D) and (E) are production costs, while clerical and administrative expenses are overheads.

Question 39

The different functions within a company (finance, production, marketing, etc) often have differing views about what is an ‘appropriate’ level of inventory. Essentially, two inventory problems need to be answered – how much to order and when to order?

If we order inventory more frequently which of the following can we expect?
A - Lower ordering costs and lower average inventory
B - Lower ordering costs and higher average inventory
C - Higher ordering costs and lower average inventory
D - Higher ordering costs and higher average inventory

Answer 39

C - Higher ordering costs and lower average inventory

If we order inventory more frequently, we can expect higher order costs but lower average levels of
inventory

Question 40

The Economic Order Quantity (EOQ) can be expressed as follows:

Square root of 2cd/h

What does h describe in this formula?
A - The cost of holding one unit of inventory for one period
B - The cost of placing one order
C - The cost of a unit of inventory
D - The customer demand for the item

​

Answer 40

A - The cost of holding one unit of inventory for one period

c is the cost of placing one order and d is the estimated usage of the inventory item over the period

Question 41

Fruit & Nut Ltd is re-evaluating its inventory control policy. Its daily demand for wooden boxes is steady at 40 a day for each of the 250 working days (50 weeks) of the year. The boxes are currently bought weekly in batches of 200 from a local supplier for £2 each. The cost of ordering the boxes from the local supplier is £64 per order, regardless of the size of the order. The inventory holding costs, expressed as a percentage of inventory value, are 25% pa. The Economic Order Quantity (EOQ) can be expressed as follows:

Identify the correct EOQ
A - 101 boxed
B - 253 boxes
C - 1,600 boxes
D - 2,262 boxes

Answer 41

C - 1,600 boxes

EOQ = 1,600 boxes and the re-order interval = 40 days
Annual demand = 40 × 250 = 10,000 boxes = d
Order cost = £64 = c
Holding cost per year per unit = 25% of £2 = £0.50 = h

EOQ = square root of 2cd/h = square root of 2 × 64 × 10,000/0.5 = 1,600 boxes

Question 42

Kate Osmond works for a company manufacturing industrial fasteners, so the company has several thousand types of inventory item. The company wants to introduce a new inventory control system
and Kate is reviewing what is available

Identify the most suitable system for an organisation with so many inventory items
A - Re-order level system
B - Periodic review system
C - ABC system
D - Just-in time system

Answer 42

C - ABC system

The ABC system is the most suitable. It aims to reduce the work involved in inventory control in a business which may have several thousand types of inventory items. It is a technique which divides inventory into sub-classifications based on their annual usage and involves using different control systems for each classification

Question 43

The key trade-off that lies at the heart of working capital management is that between
A - business stability and solvency
B - debtors and creditors
C - current assets and current liabilities
D - liquidity and profitability

Answer 43

D - liquidity and profitability
All businesses face a trade-off between being profitable (providing a return) and being liquid
(staying in business)

Question 44

Identify whether the following tasks are normally undertaken by the treasury department of a large business

Credit control:
A - Yes
B - No

Short-term investment
C - Yes
D - No

Capital investment appraisal
E - Yes
F - No

Answer 44

A - Yes
C - Yes
F - No

Credit control in many businesses is managed jointly by the treasury management and recording
transactions (receivables ledger) departments, via a separate credit control department

Treasury management involves managing cash surpluses and deficits by making short-term investments, and also managing working capital from day to day so as to optimise cash flow, including inventory, receivables (credit control) and payables management.

Management accounting will attend to capital investment appraisal

Question 45

Total usage of one item of Archer Ltd’s inventory for the next month is estimated to be 100,000 units. The costs incurred each time an order is placed are £180. The carrying cost per unit of the item each
month is estimated at £2. The purchase price of each unit is £4. The economic order quantity formula
is:

square root of (2cd)/h

When using this formula to find the optimal quantity to be ordered, identify the amounts that are
included in the calculation.

Cost per order (£180)
A - Included
B - Not included

Carrying cost per unit per month (£2)
C - Included
D - Not included

Purchase price per unit (£4)
E - Included
F - Not included

Answer 45

Cost per order (£180)
A - Included

Carrying cost per unit per month (£2)
C - Included

Purchase price per unit (£4)
F - Not included

In the formula, c = the cost of placing one order; d = the estimated usage of an inventory item over a particular period; and h = the cost of holding one unit of inventory for that period.
The purchase price per unit is not a constituent part of the formula.

Question 46

Rust Ltd invoices customers at the beginning of the month following the month in which a sale is made. All of the cash to be received in respect of these invoices occurs within two calendar months of invoicing. The company receives in cash 45% of the total gross sales value in the month of invoicing. Because Rust Ltd operates in a market where there is poor creditworthiness bad debts are 20% of total gross sales value, but there is a 10% discount for settling accounts within a calendar month of invoicing

What percentage of the sales invoiced in the first month will be received as cash in the second month by Rust Ltd?

A - 55%
B - 35%
C - 39.5%
D - 30%

Answer 46

D - 30%

If the company is offering a 10% discount for settling within the first month, then if it receives 45% of
gross sales value that must equate to 45 × 100/90 = 50% of invoices settling within that first month.
With bad debts of 20%, that leaves 30% to be collected in the second month.