Question

Loon Ltd is a small regional company specialising in the production of athletic footwear, which it sells to a variety of retail outlets in the South West of the country.

The company has recently appointed a new Credit Manager to look into the firm’s cash flow, as it has been affected by both the credit crunch and its customers’ payment pattern.

The Credit Manager has suggested the company changes the credit terms offered to its customers. Information on the existing, as well as the proposed, scheme is provided below.

At present, 20% of debtors pay one month after the invoice date, 26% pay two months after the invoice date and 50% three months after the invoice date, and 4% of trade debts are written off.

The proposed policy, would be to offer a discount of 2% for payment within one month of the invoice date. If the policy were implemented, the Credit Manager expects that 60% of debtors would pay within one month of the invoice date, 22% within two months and 15% within three months; 3% of trade debts would be written off.

The company has recently approached a bank for a term loan to increase its capacity by acquiring new machinery, which will cost £3.6m, payable at the end of each quarter. The bank has asked for a cash flow forecast for the next year.

Assume an opening balance of -£200,000.

The following information is available at the beginning of January 2016:

Actual Sales:	October	2015	£500,000
	November		£500,000
	December		£400,000
Expected Sales:	January	2016	£400,000
	February		£320,000
	March		£280,000
	April		£280,000
	May		£280,000
	June		£320,000
	July		£400,000
	August		£450,000
	September		£500,000
	October		£500,000
	November		£500,000
	December		£400,000
	January	2017	£400,000

Leather is purchased, and manufacture of footwear takes place, in the month before sale. For all types of footwear, the cost of leather is equal to 20% of sales. All invoices for sales or purchases are issued or received by the company on the last day of the month to which they relate. The company gets one-monthcredit.

You are required to:

a) Prepare the company’s cash flow forecast for the year 2016under the existing policy.

b) Prepare the cash flow forecast for the year 2016 under the new policy.

c) Discuss whether the new policy will solve the company’s cash flow problem and suggest any other ways of enhancing liquidity.

Answer 1

Ans a
Cashflow for 2016 under present policy
			In £
Receipts
Opening Cash Balance			-2,00,000
Receipt from debtors in 2016			44,44,800
		a	42,44,800
Payments
Payment to Creditors			9,26,000
		b	9,26,000
Net cash flow		(a-b)	33,18,800
Ans b
Cashflow for 2016 under proposed policy
			In £
Receipts
Opening Cash Balance			-2,00,000
Receipt from debtors in 2016			44,35,540
		a	42,35,540
Payments
Payment to Creditors			9,26,000
Payment for machine			36,00,000
		b	45,26,000
Net cash flow		(a-b)	-2,90,460

Notes	Present policy							Notes	Proposed policy
Note1	Total Sales							1	Total Sales
			Receipt from debtors in 2016			Payment to creditors					Receipt from debtors in 2016			Payment to creditors
			20%	26%	50%						60%	22%	15%
2015	October	5,00,000						2015	October	5,00,000
	November	5,00,000							November	5,00,000
	December	4,00,000							December	4,00,000
2016	January	4,00,000	80,000	1,30,000	2,50,000	80,000		2016	January	4,00,000	2,35,200	1,10,000	75,000	80,000
	February	3,20,000	80,000	1,04,000	2,50,000	80,000			February	3,20,000	2,35,200	88,000	75,000	80,000
	March	2,80,000	64,000	1,04,000	2,00,000	64,000			March	2,80,000	1,88,160	88,000	60,000	64,000
	April	2,80,000	56,000	83,200	2,00,000	56,000			April	2,80,000	1,64,640	70,400	60,000	56,000
	May	2,80,000	56,000	72,800	1,60,000	56,000			May	2,80,000	1,64,640	61,600	48,000	56,000
	June	3,20,000	56,000	72,800	1,40,000	56,000			June	3,20,000	1,64,640	61,600	42,000	56,000
	July	4,00,000	64,000	72,800	1,40,000	64,000			July	4,00,000	1,88,160	61,600	42,000	64,000
	August	4,50,000	80,000	83,200	1,40,000	80,000			August	4,50,000	2,35,200	70,400	42,000	80,000
	september	5,00,000	90,000	1,04,000	1,60,000	90,000			september	5,00,000	2,64,600	88,000	48,000	90,000
	October	5,00,000	1,00,000	1,17,000	2,00,000	1,00,000			October	5,00,000	2,94,000	99,000	60,000	1,00,000
	November	5,00,000	1,00,000	1,30,000	2,25,000	1,00,000			November	5,00,000	2,94,000	1,10,000	67,500	1,00,000
	December	4,00,000	1,00,000	1,30,000	2,50,000	1,00,000			December	4,00,000	2,94,000	1,10,000	75,000	1,00,000
total sales		46,30,000	9,26,000	12,03,800	23,15,000	9,26,000		total sales		46,30,000	27,22,440	10,18,600	6,94,500	9,26,000
total receipts			44,44,800					total receipts			44,35,540
Total Cost of purchase is 20% of total sales				9,26,000.0				Total Cost of purchase is 20% of total sales				9,26,000.0
Note2	20% of sales of dec2015 is received in jan2016 and so on so 20% of 400000 is 80000 and so on							Note2	60% of sales of dec2015 is received in jan2016 and so on so 60% *98%*400000 is 235200 and so on
	26% of sales of nov2015 is received in jan2016 and so on so 26% of 400000 is 104000 and so on								22% of sales of nov2015 is received in jan2016 and so on so 22%*98%*500000 is 110000 and so on
	50% of sales of oct2015 is received in jan2016 and so on so 20% of 500000 is 250000 and so on								15% of sales of oct2015 is received in jan2016 and so on so 15%*98%*500000 is 75000 and so on
									Discount is 2% so we took 98% of above values
Note3	Purchase cost is 20% of sales is dec2015 and so on so 20% of 400000 is 80000 and so on
								Note3	Purchase cost is 20% of sales is dec2015 and so on so 20% of 400000 is 80000 and so on

Ans C

The proposed policy will not solve the companies cashflow problem. Ways to enhance liquidity are-

1. Loan repayments should be made over a large period of time in small amounts monthly/quarterly.

2. Payment to creditors to be made after 3 months.

3.Cash receipts from debtors should not be delayed more than 2 months.