Question

A) Did the company manage its noncash working capital effectively? Explain

B)The company’s banker is worried. Why?

The comparative, unclassifi ed statement of financial position for Alton Ltd. shows the following balances at December 31:

Alton Ltd. Statement of Financial Position December 31
		2018			2017
Assets
Cash		$ 5,000			$ 36,000
Term deposits (maturing in 60 days)		0			42,000
Accounts receivable		75,000			40,000
Inventory		101,000			70,000
Land		180,000			230,000
Buildings		923,000			524,000
Accumulated depreciation—buildings		(136,000	)		(190,000	)
Equipment		100,000			70,000
Accumulated depreciation—equipment		(41,000	)		(20,000	)
Total assets		$1,207,000			$802,000
Liabilities and Shareholders’ Equity
Accounts payable		$ 29,000			$ 72,000
Income tax payable		3,000			5,000
Interest payable		18,000			13,000
Bank loan payable—current portion		56,000			40,000
Bank loan payable—non-current portion		891,000			420,000
Common shares		160,000			180,000
Retained earnings		50,000			72,000
Total liabilities and shareholders’ equity		$1,207,000			$802,000

Additional information regarding 2018:

1.		Net income was $10,000.
2.		A loss of $21,000 was recorded on the disposal of a small parcel of land. No land was purchased during the year.
3.		A gain on disposal of $15,000 was recorded when an old building was sold for $40,000 cash. A new building was purchased for $520,000 and depreciation expense on buildings for the year was $42,000.
4.		Equipment costing $72,000 was purchased while a loss of $11,000 was recorded on equipment that originally cost $42,000 and was sold for $21,000.
5.		The company received $512,000 from new bank loans during the year.
6.		Dividends were declared and paid during the year.
7.		No common shares were issued during the year but some were bought back and retired at  the amount they were originally issued at.

Answer 1

1. Working capital (WC) is defined as: Current assets (CA) - Current Liabilities (CL).

Where CA = Cash + Term deposits + Accounts receivable + Inventory and

Current Liabilities = Accounts payable + Income Tax payable + Interest payable + Bank loan payable (current portion only)

For 2017:

CA = $36,000 + $42,000 + $40,000 + $70,000 = $188,000.

CL = $72,000 + $5,000 + $13,000 + $40,000 = $130,000.

WC = $188,000 - $130,000 = $58,000.

For 2018:

CA = $5,000 + $0 + $75,000 + $101,000 = $181,000.

CL = $29,000 + $3,000 + $18,000 + $56,000 = $106,000.

WC = $181,000 - $106,000 = $75,000.

The company has not managed its working capital effectively. The cash and term deposits balance has reduced substantially whereas the accounts receivable balance has increased implying that the accounts receivable and inventory take a longer time to convert to cash. Similarly accounts payable and income tax payable have reduced implying that the credit that the company gets is reduced. This has all led to an increase in interest payable and bank loan payable. Further the non-current portion of the bank loan has increased significantly. This has given a net impact of $17,000 increase in working capital. For these reasons, the company has not managed its working capital effectively.

2. The company has a huge bank loan payable. Further the cash and term deposits balance has reduced substantially. How will the company pay its dues as and when they become due? The accounts receivable balance has increased implying that the accounts receivable and inventory take a longer time to convert to cash. Similarly accounts payable and income tax payable have reduced implying that the credit that the company gets is reduced or the company has paid off its dues earlier. The bank wil definitely be worried to the extent of the recovery of his outstanding loan.