Question

108 CHAPTER 4 MANAGING WORKING CAPITAL AND CONTROLLING CASH ACCOUNT RECONCILIATION: A service provided by banks whereby banks reconcile a business's cash accounts and create summary reconciliation reports. SWEEP ACCOUNTS: Accounts where banks automatically invest surplus cash balances in secure overnight accounts. Earnings are usually based on the federal funds traded rate, and the interest earned is credited daily. LOCKBOX: A service whereby banks assign customers a specially numbered P.O. box and collect and process payments on a daily basis. This reduces the float time of payments. ZERO BALANCE ACCOUNTS: A service whereby cash balances of all accounts are consolidated (or zeroed out) into a single account. Banks invest the surplus funds on behalf of the business. CREDIT CARD TRANSACTION FEE: A fee that credit card companies charge to merchants for processing. Application Exercises 1. What are three key methods of minimizing the amount of working capital needed? Give an example of each. 2. The cash sales and credit sales projected for Sarah's Kitchen are as follows: Cash Credit January $17,000 40,000 February $19,840 42,000 March $16,200 48,000 April $15,380 50,000 May $17,390 49,500 5. If collections of credit sales are 70% the first month and 30% the second month, what would be the cash receipts for March April, and May? 3. Using the same data as for Exercise 4-2, If Sarah's Kitchen has a 1% bad debt allowance and can collect only 29% of accounts receivable in the second month, what would be the cash receipts for March, April, and May? 4. Discuss the zero balance accounts and lockbox services that most banks offer. List three advantages and three disadvantages of each service. Feel free to visit Internet sites for banks and other financial institutions as you determine your response. 5. Ask your manager at work what credit card processing fees your hospitality operation is charged. Explain how credit card companies determine the transaction fee percentage charged to merchants 6. Search at least three websites regarding credit card foes and compile the range of trans- action fees charged by these companies. 7. You are the manager of the Potomac Inn. You would like to pay all your employees a Christmas bonus totaling $10,000. Your Owner, Joseph, agrees with your incentive rewards but wants to make sure the Inn will generate enough cash flow in December to pay the $10,000 and still maintain a minimum $5,000 cash balance. Based on the following infor .

Answer 1

Solution:

1. There are three ratios that are important in working capital management : The working capital ratio or current ratio , the collection ratio, and the inventoryturnover ratio.Working capital management aims at more efficient use of a company's resources.Keeping those three ratios at optimal levels ensures efficient working capital management.

a. Current ratio

The working capital ratio or current ratio is calculated as current assets divided by current liabilities. It is a key indicator of a company's financial health as it demonstrates its ability to meet its short - term financial obligations. Although numbers vary by industry, a working capital ratio below 1.0 generally indicates that a company is having trouble meeting its short term obligations. That is, the company's debts due in the upcoming year would not be covered by its liquid assets. In this case , the company may have to resort to selling off assets, securing long term debt or using other financingoptions to cover its short term debt obligations,

Working capital ratios of 1.2 to 2.0 are considered desirable , but a ratio higher than 2.0 may suggest that the company is not effectively using its assets to increase revenues. A high ratio may indicate that the company is not securing financing appropriately or managing its working capital efficently.

2. The collection ratio

The collection ratio is a measure of how efficiently a company manage its accounts receivables. The collection ratio calculation provides the average number of days it takes a company to receive payment after a sales transaction on credit. If a company's billing department is effective at collections attempts and customers pay their bills on time, the collection ratio will be lower. The lower a company's collection ratio, the more efficient its cash flow.

3.The Inventory Turnover Ratio

The final element of working capital management is inventory management. To operate with maximum efficiency and maintain a comfortably high level of working capital , a company must keep sufficient inventory on hand to meet customers needs while avoiding unnecessary inventory that ties up working capital.Companies typically measure how efficiently that balance is maintained by monitoring the inventory turnover ratio. The ineventory turnover ratio, calculated as revenues divided by inventory cost, reveals how rapidly a company's inventory is being sold and replenished. A relatively low ratio compared to industry peers indicates inventory levels are excessively high, while a relatively high ratio may indicate inadequate inventory levels.

2. Cash receipts for March, April and May

cash receipts of march

cash sales = 16200

collection of 70% credit sale in march = 48000* 70 % = 33600

collection of 30% credit sale of previous month = 42000*030% = 12600

Total receipts = 16200+33600+12600 =62400

cash receipts of April

cash sales = 15380

collection of 70% of credit sale in april = 50000*70% =35000

collection of 30% of credit sale in previous month = 48000 * 30% = 14400

Total receipts = 15380+35000+14400 =64780

cash receipts of May

cash sales = 17390

collection of 70% of credit sale in May = 49800 * 70% = 34650

collection 30% of credit sale in previous month = 50000 * 30% = 15000

Total receipts = 17390+34650+15000 = 67040

3. Cash receipts for March, April and May

In March

Cash sales = 16200

Collection of 70% of credit sale in March = 48000* 70% = 33600

Collection of 29% of credit sale in previous month = 42000*29% = 12180

1% bad debts allowance = 420

Total receipts = 16200+33600+12180 = 61980

In April

Cash sales = 15380

Collection of 70% of credit sale in April  = 50000 * 70% = 35000

Collection of 29% of credit sale in previous month = 48000*29% = 13920

1% bad debts allowance = 480

Total receipts = 15380+35000+13920 = 64300

In May

Cash sales = 17390

Collection of 70% of credit sale in May = 49800* 70% = 34650

Collection of 29% of credit sale in previous month = 50000*29% = 14500

1% bad debts allowance = 500

Total receipts = 17390+34650+14500 = 66540