Question

1)Please answer with workings.. Tqvm

Question 1 Woolpit Co is a manufacturing company based in the West Country of the UK. Summarised accounts for the last two years are presented below: Statements of financial position as at 30 June 2014 £'000 £'000 820 2015 £'000 £'000 1,000 Non-current assets Current assets Inventory Receivables Cash 710 990 Total assets 1,530 1,990 Equity & liabilities Ordinary shares (25p) Retained earnings 930 200 Total equity Non-current liabilities Current liabilities Overdraft Trade payables Other payables Total current liabilities 480 860 1,530 1,990 Income statements for the years ending 30 June 2014 £'000 1,800 2015 £'000 2,900 260 160 40 Revenue Gross profit Profit before tax Income tax expense 210 120 30 Profit for the period Dividends 120 40 Retained profit for the period Inflation during the last year was 5%.

Answer 1

A) Overtrading means you are selling more than what you can sell and due to which you run out of cash. For example, let's say you get an order to deliver 1000 units of bulbs. To fulfill the delivery, you need to create that 1000 units of bulbs. For that, you need to incur the expense to create those bulbs. If you run out of cash while fulfilling the order and if you won't receive the credit on time after selling it, there will be no cash in your account to proceed with the next order. That is what happened in the case of Woolpit co. in 2015. Its receivables have increased, trade payables have also increased and it ran out of cash too during the period. It means the company would be receiving money in the future, it needs to pay its loan too but it does not have any cash in its account to pay the loan currently. The company might have taken the loan and used all its proceeds to make the product and left itself with zero cash. The company can default in its payment if they don't pay on time and can be announced as a defaulter. That's why it is very important for the companies to keep some amount of assets in liquid to pay at least its short term obligations on time and save itself from default. Liquid assets will also be used to run the day-to-day operations of the company easily.

B) (i) The operating cycle of the company is a cycle from producing the goods to receive payments by selling those goods. Steps include: use cash to produce goods, then sell the goods and receive the payment of those sold goods from your customer. Its significance is to get to know that after how much time you would be receiving money from your customers. As most of the companies take a loan to produce goods. It means they have to pay back to their creditors after some time. They are using that loan to produce goods and they would be earning and paying back to their creditors once they receive money from their clients whom they have sold the goods. So by referring to the operating cycle, they would get to know when they would be receiving money after they start producing/purchasing the goods. It also helps to know how much working capital they would need in order to grow their business. The net operating cycle is referred to as a length of the time period from paying for the inventory to the sale of inventory.

Operating cycle = inventory period + account receivable period

Inventory period = 365/ inventory turnover ; Inventory turnover = COGS/Avg inventory

Account receivable period = 365/receivable turnover ; Receivable turnover = Credit sales/ avg account receivables

COGS = sales - Gross profit = 2900-260 = 2640

avg inventory = (340+420)/2 = 380

inventory turnover = 2640/380 = 6.95

So, Inventory period = 365/6.95 = 52.52 days

Avg account receivables = 465 , credit sales = 2900

account receivable period = (365/2900)*465 = 58.52 days

Operating cycle = 52+58 = 110 days (approx.)

Net operating cycle = inventory period + account receivable period - account payable period

Account payable period = 365/days payable outstanding ; Days payable outstanding = COGS/avg accounts payable

Days payable outstanding = 2640/395 = 6.68

Account payable period = 365/6.68 = 54.64 = 55 days ( approx.)

Net operating cycle = 110 - 55 = 55 days ( approx.)

(ii) The company can reduce the Operating cycle by quickly selling the inventory and/or by reducing the time period to collect cash from their credit sales.

It depends upon company to company and industry to industry whether they would need to reduce the operating cycle to a minimum possible period. It will always be seen in relation to other company's operating cycle period or the average operating cycle period of the industry. Companies will decide their length of the operating cycle after comparing the same within their specific industry.