Question

Modern Furniture Ltd competes in the modern furniture retail market alongside Adair’s, Harvey Norman and other major furniture retailers. The market is highly competitive prompting management to review working capital practices. Detailed below are relevant figures and ratios to assist you in evaluating Modern Furniture’s working capital management.

Working Capital Ratios                  2014                       2015                       2016                       2017

Accounts Receivable Days            30.0 days             38.6 days             44.0 days             51.0 days

Inventory Days                                  30.0 days             34.5 days             37.0 days             46.0 days            

Accounts Payable Days                  29.6 days             30.2 days             38.2 days             53.0 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                                     0.35mill                                 0.3mill                   .01mill                   .005mill

Sales – all on credit                          15 mill                   14 mill                   15mill                    16mill

Accounts Receivable Balance      1.2 mill                  1.5 mill                  1.8 mill                  2.2 mill

Inventory                                            0.66 mill               0.79 mill               0.9 mill                  1.17mill

Cost of Goods Sold                          8.0 mill                  8.5 mill                  8.9 mill                  9.3 mill

Accounts Payable                             0.65mill                                 0.7 mill                  0.95 mill               1.35 mill

Budgeted Figures                           

Cash on hand                                     0.3 mill                  0.3 mill                  0.31 mill               0.32 mill

Accounts Receivable Balance      1.2 mill                  1.22 mill               1.28 mill               1.35 mill

Inventory Balance                            0.7 mill                  0.72 mill               0.78 mill               0.80 mill

Accounts Payable                             0.64 mill               0.65 mill               .70 mill                  0.71 mill

Accounts Receivable Terms         30 days                30 days                30 days                30 days

Accounts Payable Terms               45 days                 45 days                 45 days                 45 days

Industry Averages

Accounts Receivable Days            30.1 days             29.6 days             30.4 days             33.1 days

Inventory Days                                  30 days                 31 days                 33 days                 32.2 days

Accounts Payable Days                  30 days                 28.5days              17 days                 15 days

Calculate :

i) the dollar value of actual net working capital each year from 2014 to 2017 for Modern Furniture Ltd

ii) the duration of the operating cash cycle each year from 2014 to 2017 for Modern Furniture Ltd

iii) interpret the meaning of each of the figures calculated above

Answer 1

Net working capital means net of current Asset and current liabilities.

1 Calculation of Actual Net Working Capital

Particulars	2014	2015	2016	2017
Current Assets
Cash in hand	0.35	0.3	0.01	0.005
Inventory	0.66	0.79	0.9	1.17
Account Receivable	1.2	1.5	1.8	2.2
Total of Current Asset (A)	2.21	2.59	2.71	3.375
Current Liabilities
Account Payable	0.65	0.7	0.95	1.35
Total of Current Liabilities (B)	0.65	0.7	0.95	1.35
Net Working Capital (A-B)	1.56	1.89	1.76	2.025

(All Figures in million $)

Operating cash Cycle calculates time taken by the business to sell off the inventory, pay off the creditors and receive cash from the debtors. It means time taken by the business to free up cash for further use in operations. As it calculates the time taken to liquidate inventory and pay creditors, lower operating cash cycle is considered better.

It is calculated following formula:

(Inventory holding period+ Account receivable days- Account Payable days)

Where:

Inventory holding period= (Inventory / COGS)*365

inventory=1/2​*(Beginning inventory+Ending Inventory)​

Account receivable days= (Account Receivables/ Net Credit Sales)*365

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

Account Payable days= (Account Payable / COGS)*365

Accounts Payable=1/2​*(Beginning Accounts Payable+Ending  Accounts Payable)

2. Calculation of duration of Actual Operating Cash Cycle

Particulars	2014	2015	2016	2017
Account Receivable Days (A)	30	38.6	44	51
Account Payable Days (B)	29.6	30.2	38.2	53
Inventory Days (C)	30	34.5	37	46
Operating Cash Cycle (A+C-B)	30.4	42.3	42.8	44

Calculation of duration of Industry Operating cash Cycle

Particulars	2014	2015	2016	2017
Account Receivable Days (A)	30.1	29.6	30.4	33.1
Account Payable Days (B)	30	28.5	17	15
Inventory Days (C)	30	31	33	32.2
Operating Cash Cycle (A+C-B)	30.1	32.1	46.4	50.3

3) From looking at the actual Operating cash cycle we conclude that it is increasing. thus, showing that Modern furniture ltd is taking longer time to free up cash. however, we cannot see these results in isolation, we need to compare the industry operating cash cycle with actual operating cash cycle of Modern furniture ltd to understand the scenario. On comparison we see that in 2014 and 2015 the Operating cash cycle of industry is lower than Modern furniture ltd. Thus, showing that in those years the company fell behind the industrial norms. In 2016 and 2017 the company seem to have out done the industrial norm as the industry operating cycle is greater than Modern furniture ltd.