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FM – May 2020 – L2 – Q5b – Working Capital Management

Evaluate the impact of introducing credit sales on total profit before tax for a company and provide management advice.

Innovate Ghana Ltd is a dealer in household consumables in Ghana. It currently sells on a cash-only basis. The company’s current annual sales are GH¢10 million. The operating cost structure is as follows:

  • Cost of sales: 55% of sales
  • Staff cost: 10% of sales
  • Marketing and distribution cost: 15% of sales

Management in a meeting concluded that introducing credit sales will help boost sales in the light of the current tightness in liquidity in the market, the drive by other competitors, and pressure from the sales team.

It is projected that total sales will grow by 50% solely from the credit sales. The customers are offered 1-month credit, and a new credit department is set up to assess and monitor these credit sales. The monthly cost of running this credit department is GH¢20,000, and bad debts are expected to be 4% of the credit sales.

To finance this credit, Innovate Ghana Ltd will borrow at an interest rate of 25% per annum.

Required:

i) Calculate the total profit before tax before the introduction of the new policy.
(4 marks)

ii) Calculate the total profit before tax after the introduction of the new policy.
(6 marks)

iii) Advise management whether the initiative should be undertaken.
(3 marks)

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FM – MAY 2017 – L1 – Q4 – Management of receivables and payables | Working Capital Management

Differentiate between factoring and invoice discounting and advise ATA Ghana Ltd on whether to take on new customers based on the proposed credit policy.

a) Factoring and Invoice Discounting are both financial services that can release the funds tied up in your unpaid invoices, involving a provider who agrees to advance money against outstanding debtor balances. However, factoring is not the same as invoice discounting.

Required:
Differentiate between factoring and invoice discounting.
(5 marks)

b) ATA Ghana Ltd is a company in Ghana engaged in the trading of commodities. The annual sales are GH¢24 million. The average age of debtors is one month, and the percentage of bad debts is 1%.

A new Marketing Director has been hired by the company to improve its sales. The new Marketing Director proposed that sales could be increased up to GH¢30 million if new customers were taken on. Taking on new customers will lengthen the average credit period to 2 months and increase bad debts to 1.5% of sales.

The Finance Manager provided that the variable cost is 70% of the selling price and the company’s cost of capital is 20%.

Required:
Advise whether the company should take on the new customers.
(10 marks)

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FM – Nov 2023 – L2 – Q5 – Management of receivables and payables | Working Capital Management

Evaluate different credit policies, compute the cost of forgoing a discount, and explain types of financial risks managed by a treasury function.

a) Wahala Ltd wants to employ more liberal credit standards to increase sales. The current annual sales figure is GH¢30 million. Currently, the firm has an average collection period of 30 days. Three alternative credit policies are on the table for evaluation and selection. The management team believes that the alternative credit policies will result in the following:

Factor Alternative Credit Policy A Alternative Credit Policy B Alternative Credit Policy C
Increase in sales from the current level GH¢2.2 million GH¢3.1 million GH¢5.4 million
Average collection period for incremental sales (days) 45 60 150
Bad-debt losses on incremental sales 1.50% 3.50% 8.50%

The prices of its products average GH¢30.50 per unit and variable costs average GH¢21.35 per unit. The company’s pre-tax opportunity cost of funds is 35%.

Required:
i) Evaluate each of the three alternative liberal credit policies and advise the company on which credit policy it should pursue. (Assume a 360-day year). (12 marks)
ii) Suppose the company introduces a discount policy of 2/10 net 45. Compute the cost to a customer who forgoes the discount. (3 marks)

b) The treasury unit of a company performs various functions, including financial risk management.
Required:
Explain TWO (2) types of financial risks the treasury function manages. (5 marks)

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FM – NOV 2016 – L2 – Q2 – Working Capital Management

Discusses the causes of overcapitalization and overtrading, advises on credit policy changes, and explains stock splits and scrip issues.

a) Explain THREE causes each of the following situations:

i) Overcapitalized (3 marks)

ii) Overtrading (3 marks)

b) SAP Petroleum Ltd is considering relaxing its credit policy to boost sales. The change will increase the average collection period from 30 days to 60 days. The review is expected to increase sales by 25%. The current annual sales are GH¢ 6,000,000. Selling price per litre is GH¢ 30, variable cost per litre is GH¢ 27, and additional stock level is GH¢250,000.

Required:

i) Advise on whether to extend the period to customers if all customers take the longer credit of 2 months. (5 marks)

ii) Advise if existing customers do not change their payment terms and only new ones take the longer credit. (4 marks)

c) i) Explain the concepts of stock split and scrip issue and identify the main difference between the two. (3 marks)

ii) Explain why a company will embark on a scrip issue. (2 marks)

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FM – April 2022 – L2 – Q5a – Management of receivables and payables

Evaluate the impact of a proposed change in credit policy on Poh-Poh Electronics Ltd’s profitability and recommend whether the policy should be implemented, along with advice on procedures for receivables collection.

Poh-Poh Electronics Ltd is a wholesale distributor of household electrical products of major electronic brands. The company currently sells on credit to all its customers. Although the credit term is net 20 days, the receivables turnover days have been 15 days. The company’s annual credit sales revenue is GH¢80 million, and its contribution margin ratio is 30%. Bad debt is 2% of sales revenue, and credit collection cost is GH¢50,000 per annum.

Management is considering extending the credit period to net 30 days. It is expected that the implementation of this proposal would attract new customers, and the annual revenue would increase by 20%. It is also expected that both the existing and the new customers will probably take the full 30 days credit. To mitigate the probable lengthening in the receivables turnover days, management proposes that the extension in the credit period be combined with the introduction of a cash discount policy of 2% on all payments made within the first 10 days of the credit period. It is expected that 30% of all customers will pay their accounts early to take the discount. Consequently, the receivables turnover days would increase to 24 days. While the bad debt will remain at 2% of sales revenue, the annual credit collection cost will increase to GH¢65,000.

The company’s cost of capital is 24%.

Required:
i) Evaluate the proposed change in the credit policy and recommend whether the proposed change should be implemented. (9 marks)
ii) Advise the management team on THREE (3) procedures for the collection of its receivables. (6 marks)

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FM – Nov 2019 – L2 – Q5 – Inventory Management | Working Capital Management

Explain the impact of different working capital policies on profitability and liquidity, calculate profit under different credit policies, and explain reasons and costs associated with holding stock.

a) In driving the profitability and liquidity position of an organization in the current local and global business environment, one area that has become the center of focus or attention to Management is how working capital is managed. Aggressive, moderate, and conservative policies to working capital management have implications on the profitability and liquidity positions of the organization.

Required:
In the light of the above, explain and demonstrate the impact of each of the policies below on profitability and liquidity:
i) Aggressive Working Capital Management (2 marks)
ii) Moderate Working Capital Management (2 marks)
iii) Conservative Working Capital Management (2 marks)

b) Taaba Oil Ghana Ltd is an Oil Marketing Company operating in the downstream sector of the Oil and Gas industry in Ghana. The company initially was offering 4 weeks credit to its retailers until it changed its strategy to reduce the credit period from 4 weeks to 2 weeks to manage down its financing cost and bad debt.

Under the 4 weeks credit regime, annual credit sales were 500 million liters. The profit made per liter before financing charges and bad debt was GH¢0.20. The total working capital was GH¢250 million, but 50% was funded through trade credit and the remaining 50% was through Bank Overdraft at an interest rate of 25% per annum. The cost of trade credit was already factored into the margin. Bad debt was GH¢0.01 per liter of the credit sales.

The change in policy from 4 weeks to 2 weeks was done immediately without prior advance discussion and notice period granted to retailers who were also selling on credit to their customers.

After operating the new credit policy, the volume of sales was negatively impacted as sales volume per annum dropped by 25% and bad debts increased by 100% due to pressure on the working capital of the retailers. As the new Finance Manager for Taaba Oil Ghana Ltd, you are tasked to review this policy.

Required:
i) Calculate the profit under the old policy. (4 marks)
ii) Calculate the profit under the new policy. (4 marks)
iii) Based on your calculations above, advise management whether to revert to the old policy or maintain the new policy. (1 mark)

c) Holding stock and sometimes over-stocking come at a great cost to a company. Notwithstanding these costs, it is sometimes necessary to hold stock or even overstock for the smooth running of the company.

Required:
i) Explain TWO (2) reasons for holding stock. (2 marks)
ii) State and explain THREE (3) costs associated with holding stocks. (3 marks)

 

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FM – MAY 2018 – L2 – Q4 – Working Capital Management

Evaluates the impact of extending credit terms on a company’s sales, bad debts, and working capital financing costs.

Adjaye Ltd has current sales of GH¢1.5 million per year. Cost of sales is 75% of sales and bad debts are 1% of sales. Cost of sales comprises 80% variable costs and 20% fixed costs, while the company’s required rate of return is 12%. Adjaye Ltd currently allows customers 30 days credit, but is considering increasing this to 60 days credit in order to increase sales.

It has been estimated that this change in policy will increase sales by 15% and bad debts will increase from 1% to 4%. It is not expected that the policy change will result in an increase in fixed costs, and creditors and stock will be unchanged.

Required:

Advise whether Adjaye Ltd should introduce the proposed policy. Support your answer with relevant computations.

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FM – May 2020 – L2 – Q5b – Working Capital Management

Evaluate the impact of introducing credit sales on total profit before tax for a company and provide management advice.

Innovate Ghana Ltd is a dealer in household consumables in Ghana. It currently sells on a cash-only basis. The company’s current annual sales are GH¢10 million. The operating cost structure is as follows:

  • Cost of sales: 55% of sales
  • Staff cost: 10% of sales
  • Marketing and distribution cost: 15% of sales

Management in a meeting concluded that introducing credit sales will help boost sales in the light of the current tightness in liquidity in the market, the drive by other competitors, and pressure from the sales team.

It is projected that total sales will grow by 50% solely from the credit sales. The customers are offered 1-month credit, and a new credit department is set up to assess and monitor these credit sales. The monthly cost of running this credit department is GH¢20,000, and bad debts are expected to be 4% of the credit sales.

To finance this credit, Innovate Ghana Ltd will borrow at an interest rate of 25% per annum.

Required:

i) Calculate the total profit before tax before the introduction of the new policy.
(4 marks)

ii) Calculate the total profit before tax after the introduction of the new policy.
(6 marks)

iii) Advise management whether the initiative should be undertaken.
(3 marks)

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FM – MAY 2017 – L1 – Q4 – Management of receivables and payables | Working Capital Management

Differentiate between factoring and invoice discounting and advise ATA Ghana Ltd on whether to take on new customers based on the proposed credit policy.

a) Factoring and Invoice Discounting are both financial services that can release the funds tied up in your unpaid invoices, involving a provider who agrees to advance money against outstanding debtor balances. However, factoring is not the same as invoice discounting.

Required:
Differentiate between factoring and invoice discounting.
(5 marks)

b) ATA Ghana Ltd is a company in Ghana engaged in the trading of commodities. The annual sales are GH¢24 million. The average age of debtors is one month, and the percentage of bad debts is 1%.

A new Marketing Director has been hired by the company to improve its sales. The new Marketing Director proposed that sales could be increased up to GH¢30 million if new customers were taken on. Taking on new customers will lengthen the average credit period to 2 months and increase bad debts to 1.5% of sales.

The Finance Manager provided that the variable cost is 70% of the selling price and the company’s cost of capital is 20%.

Required:
Advise whether the company should take on the new customers.
(10 marks)

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FM – Nov 2023 – L2 – Q5 – Management of receivables and payables | Working Capital Management

Evaluate different credit policies, compute the cost of forgoing a discount, and explain types of financial risks managed by a treasury function.

a) Wahala Ltd wants to employ more liberal credit standards to increase sales. The current annual sales figure is GH¢30 million. Currently, the firm has an average collection period of 30 days. Three alternative credit policies are on the table for evaluation and selection. The management team believes that the alternative credit policies will result in the following:

Factor Alternative Credit Policy A Alternative Credit Policy B Alternative Credit Policy C
Increase in sales from the current level GH¢2.2 million GH¢3.1 million GH¢5.4 million
Average collection period for incremental sales (days) 45 60 150
Bad-debt losses on incremental sales 1.50% 3.50% 8.50%

The prices of its products average GH¢30.50 per unit and variable costs average GH¢21.35 per unit. The company’s pre-tax opportunity cost of funds is 35%.

Required:
i) Evaluate each of the three alternative liberal credit policies and advise the company on which credit policy it should pursue. (Assume a 360-day year). (12 marks)
ii) Suppose the company introduces a discount policy of 2/10 net 45. Compute the cost to a customer who forgoes the discount. (3 marks)

b) The treasury unit of a company performs various functions, including financial risk management.
Required:
Explain TWO (2) types of financial risks the treasury function manages. (5 marks)

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FM – NOV 2016 – L2 – Q2 – Working Capital Management

Discusses the causes of overcapitalization and overtrading, advises on credit policy changes, and explains stock splits and scrip issues.

a) Explain THREE causes each of the following situations:

i) Overcapitalized (3 marks)

ii) Overtrading (3 marks)

b) SAP Petroleum Ltd is considering relaxing its credit policy to boost sales. The change will increase the average collection period from 30 days to 60 days. The review is expected to increase sales by 25%. The current annual sales are GH¢ 6,000,000. Selling price per litre is GH¢ 30, variable cost per litre is GH¢ 27, and additional stock level is GH¢250,000.

Required:

i) Advise on whether to extend the period to customers if all customers take the longer credit of 2 months. (5 marks)

ii) Advise if existing customers do not change their payment terms and only new ones take the longer credit. (4 marks)

c) i) Explain the concepts of stock split and scrip issue and identify the main difference between the two. (3 marks)

ii) Explain why a company will embark on a scrip issue. (2 marks)

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FM – April 2022 – L2 – Q5a – Management of receivables and payables

Evaluate the impact of a proposed change in credit policy on Poh-Poh Electronics Ltd’s profitability and recommend whether the policy should be implemented, along with advice on procedures for receivables collection.

Poh-Poh Electronics Ltd is a wholesale distributor of household electrical products of major electronic brands. The company currently sells on credit to all its customers. Although the credit term is net 20 days, the receivables turnover days have been 15 days. The company’s annual credit sales revenue is GH¢80 million, and its contribution margin ratio is 30%. Bad debt is 2% of sales revenue, and credit collection cost is GH¢50,000 per annum.

Management is considering extending the credit period to net 30 days. It is expected that the implementation of this proposal would attract new customers, and the annual revenue would increase by 20%. It is also expected that both the existing and the new customers will probably take the full 30 days credit. To mitigate the probable lengthening in the receivables turnover days, management proposes that the extension in the credit period be combined with the introduction of a cash discount policy of 2% on all payments made within the first 10 days of the credit period. It is expected that 30% of all customers will pay their accounts early to take the discount. Consequently, the receivables turnover days would increase to 24 days. While the bad debt will remain at 2% of sales revenue, the annual credit collection cost will increase to GH¢65,000.

The company’s cost of capital is 24%.

Required:
i) Evaluate the proposed change in the credit policy and recommend whether the proposed change should be implemented. (9 marks)
ii) Advise the management team on THREE (3) procedures for the collection of its receivables. (6 marks)

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FM – Nov 2019 – L2 – Q5 – Inventory Management | Working Capital Management

Explain the impact of different working capital policies on profitability and liquidity, calculate profit under different credit policies, and explain reasons and costs associated with holding stock.

a) In driving the profitability and liquidity position of an organization in the current local and global business environment, one area that has become the center of focus or attention to Management is how working capital is managed. Aggressive, moderate, and conservative policies to working capital management have implications on the profitability and liquidity positions of the organization.

Required:
In the light of the above, explain and demonstrate the impact of each of the policies below on profitability and liquidity:
i) Aggressive Working Capital Management (2 marks)
ii) Moderate Working Capital Management (2 marks)
iii) Conservative Working Capital Management (2 marks)

b) Taaba Oil Ghana Ltd is an Oil Marketing Company operating in the downstream sector of the Oil and Gas industry in Ghana. The company initially was offering 4 weeks credit to its retailers until it changed its strategy to reduce the credit period from 4 weeks to 2 weeks to manage down its financing cost and bad debt.

Under the 4 weeks credit regime, annual credit sales were 500 million liters. The profit made per liter before financing charges and bad debt was GH¢0.20. The total working capital was GH¢250 million, but 50% was funded through trade credit and the remaining 50% was through Bank Overdraft at an interest rate of 25% per annum. The cost of trade credit was already factored into the margin. Bad debt was GH¢0.01 per liter of the credit sales.

The change in policy from 4 weeks to 2 weeks was done immediately without prior advance discussion and notice period granted to retailers who were also selling on credit to their customers.

After operating the new credit policy, the volume of sales was negatively impacted as sales volume per annum dropped by 25% and bad debts increased by 100% due to pressure on the working capital of the retailers. As the new Finance Manager for Taaba Oil Ghana Ltd, you are tasked to review this policy.

Required:
i) Calculate the profit under the old policy. (4 marks)
ii) Calculate the profit under the new policy. (4 marks)
iii) Based on your calculations above, advise management whether to revert to the old policy or maintain the new policy. (1 mark)

c) Holding stock and sometimes over-stocking come at a great cost to a company. Notwithstanding these costs, it is sometimes necessary to hold stock or even overstock for the smooth running of the company.

Required:
i) Explain TWO (2) reasons for holding stock. (2 marks)
ii) State and explain THREE (3) costs associated with holding stocks. (3 marks)

 

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FM – MAY 2018 – L2 – Q4 – Working Capital Management

Evaluates the impact of extending credit terms on a company’s sales, bad debts, and working capital financing costs.

Adjaye Ltd has current sales of GH¢1.5 million per year. Cost of sales is 75% of sales and bad debts are 1% of sales. Cost of sales comprises 80% variable costs and 20% fixed costs, while the company’s required rate of return is 12%. Adjaye Ltd currently allows customers 30 days credit, but is considering increasing this to 60 days credit in order to increase sales.

It has been estimated that this change in policy will increase sales by 15% and bad debts will increase from 1% to 4%. It is not expected that the policy change will result in an increase in fixed costs, and creditors and stock will be unchanged.

Required:

Advise whether Adjaye Ltd should introduce the proposed policy. Support your answer with relevant computations.

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