Tutorial Answers - Short-term Finance and Planning

Q1.

(a) A 10-day collection period implies all receivables outstanding from the previous quarter are
collected within 2 weeks and:

(90 – 10)/90 = 8/9 of current sales are collected. So:

Cash Collections in Q1=£145m+£824m8/9=£877.44m

Cash Collections in Q2=£91.56m+£920m8/9=£909.34m
Cash Collections in Q3=£102.22+£620m8/9=£653.33m
Cash Collections in Q4=£68.89+£1,6008/9=£1,491.11m

Q1 Q2 Q3 Q4
£ £ £ £
Beginning receivables 145.00 91.56 102.22 68.89
Sales 824.00 920.00 620.00 1,600.00
Cash collections –877.44 –909.34 –653.33 –1,491.11
Ending receivables 91.56 102.22 68.89 177.78

(b) A 20-day collection period implies all receivables outstanding from the previous quarter are
collected in the current month, and:

(90-20)/90 = 7/9 of current sales are collected. So:

Cash Collections in Q1=£145m+£824m7/9=£785.89m

Cash Collections in Q2=£183.11m+£920m7/9=£898.67m
Cash Collections in Q3=£204.44+£620m7/9=£686.66m
Cash Collections in Q4=£137.78+£1,6007/9=£1,382.22m

Q1 Q2 Q3 Q4
£ £ £ £
Beginning receivables 145.00 183.11 204.44 137.78
Sales 824.00 920.00 620.00 1,600.00
Cash collections –785.89 –898.67 –686.66 –1,382.22
Ending receivables 183.11 204.44 137.78 355.56
(c) A 30-day collection period implies all receivables outstanding from the previous quarter are
collected in the current quarter, and:

(90-30)/90 = 2/3 of current sales are collected. So:

Cash Collections in Q1=£145m+£824m2/3=£694.33m

Cash Collections in Q2=£274.67m+£920m2/3=£888.00m
Cash Collections in Q3=£306.67+£620m2/3=£720.00m
Cash Collections in Q4=£206.67+£1,6002/3=£1,273.34m

Q1 Q2 Q3 Q4
£ £ £ £
Beginning receivables 145.00 274.67 306.67 206.67
Sales 824.00 920.00 620.00 1,600.00
Cash collections –694.33 –888.00 –720.00 –1,273.34
Ending receivables 274.67 306.67 206.67 533.33

Q2.

(a) Increase. If receivables go up, the time to collect the receivables would increase, which increases
the operating cycle.

(b) Increase. If credit repayment times are increased, customers will take longer to pay their bills, which
will lead to an increase in the operating cycle.

(c) Decrease. If the inventory turnover increases, the inventory period decreases.

(d) No change. The trade payables period is part of the cash cycle, not the operating cycle.

(e) Increase. If the receivables turnover decreases, the receivables period increases.

(f) No change. Payments to suppliers affects the accounts payable period, which is part of the cash cycle,
not the operating cycle.

Q3.

(a) Increase, Increase. If the terms of the cash discount are made less favourable to customers, the trade
receivables period will lengthen. This will increase both the cash cycle and the operating cycle.

(b) Increase, No change. This will shorten the trade payables period, which will increase the cash cycle.
It will have no effect on the operating cycle since the accounts payable period is not part of the operating
cycle.
(c) Decrease, Decrease. If more customers pay in cash, the trade receivables period will decrease. This
will decrease both the cash cycle and the operating cycle.

(d) Decrease, Decrease. Assume that the trade payables period does not change. Fewer raw materials
purchased will reduce the inventory period, which will decrease both the cash cycle and the operating
cycle.

(e) Decrease, No change. If more raw materials are purchased on credit, the trade payables period will
tend to increase, which would decrease the cash cycle. The change in credit purchases made on credit
will not affect the inventory period or the accounts receivable period, so the operating cycle will not
change.

(f) Increase, Increase. If more goods are produced for inventory, the inventory period will increase. This
will increase both the cash cycle and operating cycle.

Q4.

(a) The operating cycle is the inventory period plus the receivables period.
Average inventory = (8,413 + 10,158) / 2 = 9,285.5
Inventory turnover = COGS/Average inventory = 52,827/9,285.5 = 5.6892 times
Inventory period = 365 days/Inventory turnover = 365 days/5.6892 = 64.16 days

Average receivables= (5,108 + 5,439) / 2 = 5,273.5

Receivables turnover = Credit sales/Average receivables = 67,312 / 5,273.5 = 12.7642 times
Receivables period = 365 days/Receivables turnover = 365 days/12.7642 = 28.60 days

So, the operating cycle is = Inventory period + Receivables period

= 64.16 days + 28.60 days = 92.75 days

The cash cycle is the operating cycle minus the payables period. The payables turnover and payables
period are:

Average payables= (6,927 + 7,625) / 2= 7,276

Payables turnover = COGS/Average payables = 52,827/ 7,276 = 7.2604 times
Payables period = 365 days/Payables turnover = 365 days/7.2604 = 50.27 days

So, the cash cycle is = operating cycle - payables period

= 92.75 days – 50.27 days = 42.48 days

The firm is receiving cash on average 42.48 days after it pays its bills.
(b) The firm can increase its cash level by investing less in inventory (keeping a safe buffer though),
reducing the days in receivables (less credit sales) and increasing the days in payables (longer deferred
payments for purchases). You could provide any other sensible suggestion and more detailed
explanation is required.

Homework:

Q5.

(a) The operating cycle is the inventory period plus the receivables period.
Average inventory = (44,234 + 34,048) / 2 = 39,141
Inventory turnover = COGS/Average inventory = 120,400/39,141 = 3.076 times
Inventory period = 365 days/Inventory turnover = 365 days/3.076 = 118.66 days

Average receivables= (43,211 + 35,532) / 2 = 39,371.5

Receivables turnover = Credit sales/Average receivables = 360,302 / 39,371.5 = 9.151 times
Receivables period = 365 days/Receivables turnover = 365 days/9.151 = 39.89 days

So, the operating cycle is = Inventory period + Receivables period

= 118.66 days + 39.89 days = 158.55 days

The cash cycle is the operating cycle minus the payables period. The payables turnover and payables
period are:

Average payables= (35,603 + 53,503) / 2= 44,553

Payables turnover = COGS/Average payables = 120,400/ 44,553 = 2.702 times
Payables period = 365 days/Payables turnover = 365 days/2.702 = 135.09 days

So, the cash cycle is = operating cycle - payables period

= 158.55 days – 135.09 days = 23.46 days

The firm is receiving cash on average 23.46 days after it pays its bills.

(b) The firm can increase its cash level by investing less in inventory (keeping a safe buffer though),
reducing the days in receivables (less credit sales) and increasing the days in payables (longer deferred
payments for purchases). You could provide any other sensible suggestion and more detailed
explanation is required.
Q6.

First, we need to calculate the sales from the last quarter of the previous year. Since 50% of the sales
were collected in that quarter, the sales figure must have been:

Sales (last quarter of previous year) = £81,000,000 / (1 – 0.50) = £162,000,000

Because the quarterly growth rate is 20%, so:

Sales in Q2 = £100m  (1+20%) = £120m

Sales in Q3 = £120m  (1+20%) = £144m
Sales in Q4 = £144m  (1+20%) = £172.8m

Now we can compute the sale projection for each quarter after incorporating the sales growth and the
seasonal adjustments. The sales figures for each quarter will be:

Q1 Q2 Q3 Q4
£ £ £ £
Sales (basic trend) 100,000,000 120,000,000 144,000,000 172,800,000
Seasonal adjustment 0 –10,000,000 –5,000,000 15,000,000
Sales projection 100,000,000 110,000,000 139,000,000 187,800,000

Since 50% of sales are collected in the quarter the sales are made, and 45% of sales are collected in the
quarter after the sales are made, so:

Cash Collections in Q1 = £100,000,000  50% + £162,000,000  45% = £122,900,000

Cash Collections in Q2 = £110,000,000  50% + £100,000,000  45% = £100,000,000
Cash Collections in Q3 = £139,000,000  50% + £110,000,000  45% = £119,000,000
Cash Collections in Q4 = £187,800,000  50% + £139,000,000  45% = £156,450,000

The cash budget is:

Q1 Q2 Q3 Q4
£ £ £ £
Cash collected within quarter 50,000,000 55,000,000 69,500,000 93,900,000
Collection from previous quarter 72,900,000 45,000,000 49,500,000 62,550,000
Cash collection from sales 122,900,000 100,000,000 119,000,000 156,450,000