Question

Fabulous Fashion Ltd operates a chain of high end ladies’ fashion stores with locations in all major capital cities throughout Australia. It’s been established since 2010 and has seen tremendous growth but more recently has seen several fashion labels from overseas enter the Australian market resulting in an increase in competition. This increased competition has placed significant pressure on containing costs and drawn management’s attention to a review of working capital practices. Detailed below are relevant figures and ratios to assist you in evaluating Fabulous Fashion’s working capital management. Working Capital Ratios 2016 2017 2018 2019 Accounts Receivable Days 14.0 days 18.1 days 23.1 days 31.9 days Inventory Days 16.0 days 19.1 days 21.9 days 25.0 days Accounts Payable Days 14.1 days 21. days 29.0 days 37.0 days Note: Ratios are based on assuming end year figures are the average throughout the majority of the year Extracts from Financial Statements Cash on hand 0.20 mill 0.15 mill .01 mill (.003 mill) Sales – all on credit 8.1 mill 6.9 mill 8.0 mill 9.0 mill Accounts Receivable Balance 0.3069 mill 0.3453 mill 0.5044 mill 0.7894 mill Inventory 0.1754 mill 0.2186 mill 0.2712 mill 0.3219 mill Cost of Goods Sold 4.0 mill 4.2 mill 4.5 mill 4.7 mill Accounts Payable 0.1534 mill 0.2417 mill 0.3574 mill 0.4762mill Budgeted Figures Cash on hand 0.3 mill 0.3 mill 0.31 mill 0.32 mill Accounts Receivable Balance 0.30 mill 0.31 mill 0.37 mill 0.38 mill Inventory Balance 0.16 mill 0.17 mill 0.20 mill 0.21 mill Accounts Payable 0.16 mill 0.17 mill .19 mill 0.20 mill Accounts Receivable Terms 14 days 14 days 14 days 14 days Accounts Payable Terms 30 days 30 days 30 days 30 days Industry Averages Accounts Receivable Days 14 days 14 days 15 days 16 days Inventory Days 15 days 16 days 16 days 15 days Accounts Payable Days 30 days 28 days 25 days 20 days (a) Calculate (show full workings to your answer): (i) the dollar value of actual net working capital each year from 2016 to 2019 for Fabulous Fashion. (ii) the duration of the operating cash cycle each year from 2016 to 2019 for Fabulous Fashion. (iii) interpret the meaning of each of the figures calculated above (b) Review Fabulous Fashion’s working capital management performance utilizing calculations in (a) above and information provided such as trends / benchmark figures / industry averages and budgets (300-word limit). Once you have analyzed their performance, provide some strategies and recommendations to assist in improving any weaknesses in working capital management referring to the management of components of working capital including cash, inventory, accounts receivable and accounts payable. As part of your recommendations identify the associated potential benefits and costs of each recommendation. (400-word limit) with references

Answer 1

Dollar value of net working Capital.

Net working capital = Current Asset - Current Liabilities.

(Amount in Million $)

Particulars	2016	2017	2018	2019
Current Assets
Cash In Hand	0.20	0.15	0.01	(.003)
Inventory	0.1754	0.2186	0.2712	0.3219
Account Receivable	0.3069	0.3453	0.5044	0.7894
Total Current Assets (A)	0.6823	0.7139	0.7856	1.1083
Current Liabilities
Account Payable	0.1534	0.2417	0.3574	0.4762
Total Current Liabilities (B)	0.1534	0.2417	0.3574	0.4762
Net Working Capital (A-B)	0.5289	0.4722	0.4282	0.6321

2. Calculation of duration of the operating cash cycle

Formula :( Account receivable days+ Inventory days- Account Payable days)

Particulars	2016	2017	2018	2019
Account Receivable Days (A)	14.0	18.1	23.1	31.9
Inventory Days (B)	16.0	19.1	21.9	25.0
Account Payable Days (C)	14.1	21	29.0	37.0
Operating Cash Cycle (A+B-C)	15.9	16.2	16	19.9

3. Net working Capital shows the amount of money company has to carry out day to day business. Positive Net working capital is ideal as it shows that company has enough current assets to pay off their current liabilities.

Operating Cash cycle calculates days taken by the company to Sell off their inventory, pay off their creditors and retrieve payment from debtors. It helps to find the time period for which cash is held up.Lower Operating cash cycle is considered better.

Account receivable days shows average days taken to retrieve cash from debtors. It is calculated by following formula:

(Account receivable/Net Credit Sales)*365

where Account receivable= 1/2*( Beginning Account Receivable + Ending Account receivable)

Account Payable days shows average time taken to pay off creditors,. Formula:

(Account Payable/ COGS)*365

Where:

Account Payable =1/2*( Beginning Account Payable + Ending Account Payable)

Inventory Days: Average Time taken to Sell off Inventory and free up cash. Calculated by:

(Inventory/COGS)*365

Inventory days= 1/2*( Beginning Inventory + Ending Inventory)

4. Industry Operating Cash Cycle

Particulars	2016	2017	2018	2019
Account Receivable Days (A)	14	14	15	16
Inventory Days (B)	15	16	16	15
Account Payable Days (C)	30	28	25	20
Operating Cash Cycle (A+B-C)	-1	2	6	11

Budgeted Net working Capital

   (Amount in Million $)

Particulars	2016	2017	2018	2019
Current Assets
Cash In Hand	0.3	0.3	0.31	0.32
Inventory	0.16	0.17	0.20	0.21
Account Receivable	0.30	0.31	0.37	0.38
Total Current Assets (A)	0.76	0.78	0.88	0.91
Current Liabilities
Account Payable	0.16	0.17	0.19	0.20
Total Current Liabilities (B)	0.16	0.17	0.19	0.20
Net Working Capital (A-B)	0.6	0.61	0.69	0.71

• From comparing actual Operating cash cycle with Industry Operating cash Cycle we see that the Fabulous fashion ltd operating cash cycle is higher  than Industry standards. This shows that the company has fallen behind the standard. It is taking longer to free up cash as compared to other companies in the fashion industry. Also by its own standards, the operating cash cycle has constantly increased over last four years ( 2016 to 2019). Only in 2018 there is a very minute dip.
• From Comparing the actual net working capital with budgeted net working capital we have come to a conclusion that though the actual results are positive and continuously increasing ( 2016 to 2019), the company has not met its own budgeted target.

Thus, we have come to a conclusion that the company has not only failed to meet its own working capital targets it has also fallen behind comply with industrial norms in case of operating cash cycle.

5. Since the company is weak in managing working capital it may try to strengthen following aspects :

a) Do not Over stock the Inventory. Overstocking leads to tying up of cash. Do not buy inventory that are not in demand. Try to sell the finished products as soon as possible.'

b) Try to reduce debtors payment period by offering incentives in the form of cash discount. Prioritize those customers  who pay early in terms of services. Identify frequent defaulters and reduce business with them.

c) Account payable need to be paid off as soon as possible. Try out those vendors who offer discount at early payments. Maintain good relationship with vendors, this will help the company in case of cash shortage.

d) Use Online medium or bank instruments for payments and receipts as much as possible. This helps in reduction of fraud and easy handling of cash. Time is also saved by using this option. Some times the customers do not have handy cash. This arrangement is way more fruitful is such situation.