QN 4

a) The logical mistake the production manager is making is assuming that the 1% cost of taking advantage of
the discount is the only cost involved. In reality, there is an opportunity cost associated with not taking
advantage of the discount, as the company could invest the saved funds elsewhere to potentially earn a higher
return.

b) PLAZA manufacturing company should take advantage of the discount. By paying within the discount
period, the company can save money on its raw material purchases and improve its overall financial
performance. This can be agreed base on Cost-Benefit analysis, mathematically the discount must be taken if
it has low credit cost and the decisions not to take it they base on opportunity cost of not taking it and the cost
of credit vs investment of same amount of money on the remaining days to see which is
beneficial.Mathematically can be shown as follows

Calculate the opportunity cost of not taking the discount

Opp cost =((100 + Discount%) / (100 - Discount%)) ^ (365 / (Total credit period – Discount days)) – 1

Data

Discount = 1%

Net days = 30

=((100 + 1) / (100 - 1%)) ^ 365 / 20 - 1 = 20%

From the point of view the cost of not taking discount was high compare to the cost of credit that will be taken
from bank which was 12%, from that point it means that the company will pay more if it opt not to take
discount by 9% (20-12-1)%

Alternatively

Now let us assume that Plaza Ltd. can invest the additional cash and can obtain an annual return of 12% and the
amount of invoice is Tsh. 10,000. The alternatives are as follows:

Particulars Refuse Discount Accept Discount

Payment to the supplier (Accounts Tsh. 10,000 Tsh. 9,900

Payables)

Return from investing Tsh. 10,000 between (-68) Tsh 9932

day 10 and day 30
((20 / 365) * 10,000 * 12%)

Net Cost Tsh. 9,932 Tsh. 9,900

Looking at the above, it would better for the company to accept the discount, as we pay less by Tsh. 32/-
accepting the discount proposal than to retain trade payables and pay on the due date which is Rs. 9,932 /- (Tsh.
32 higher than what it would be required to pay if PLAZA Ltd refuses the discount)

To summarize it, it is clear that accounts payable has costs associated with it. By using the accounts payable
judiciously, a firm can reduce the burden on Working Capital.

c) If PLAZA manufacturing company can't borrow from the bank and has to rely on trade credit funds, they
should alter their payable policy to reduce annual interest costs by paying within the discount period whenever
available. This will help the company save money on its purchases and improve its cash flow position.
Additionally, they could negotiate with suppliers for extended payment terms in exchange for early payment
discounts.

QN 5(A):
Credit policy; refers to the strategy decision and guidelines set by the company’s management to manage the
extension of credit to the customers .Credit policy can either be liberal or tight, a liberal credit policy involves
offering more generous credit terms to customers, such as longer payment periods and higher credit limits. This
can attract more customers and stimulate sales but may increase the risk of bad debts. And a tight credit policy
involves stricter terms, like shorter payment periods and lower credit limits. While it reduces the risk of bad
debts, it may deter some customers and potentially limit sales growth.

Credit policy can change due to various reasons and the following are four factors for the change of
credit policy.

Market Conditions; this involves Assessing the current economic landscape, including interest rates, inflation,
and industry trends. A shift in market conditions may necessitate adjustments to credit terms to remain
competitive or mitigate risk.

Customer Risk Profile; deals with Evaluation of the creditworthiness of existing and potential customers.
Changes in customer payment behavior, default rates, or credit scores may indicate a need to tighten or loosen
credit policies.

Cash Flow Management; consider the impact of credit policy changes on cash flow. Tightening credit terms
may improve cash flow by reducing outstanding receivables, while loosening terms may stimulate sales but
potentially strain liquidity.

Competitive Landscape; analyze the credit policies of competitors. Adjustments may be necessary to match
or differentiate from competitors' offerings, balancing risk and reward in attracting and retaining customers.

Generally; Credit policy may change due to various factors since the company may decide to avoid and reduce
credit risk from bad debts and defaults which may face the company.

QN 5( b):
Data Given

For ABM LTD

Total sales 14,400,000

Credit sales 80%

Factoring service advance 90% total credits

Fee on factoring service 2%

Commission 4% on total debts

Management cost 51840 annually

Bad debts 1% on credit sales

For BOCM BANK

Factor service advance 90%

Interest rate 18%

Processing fee 2%

Workings

Total credit sales per annum = 14,400,000x 80%

= 11,520,000

Total credit per month= 11,520,000x1/12

= 960,000

Amount for factoring =960,000x90%

=864,000

ABM LTD
Fee for factoring service (864,000x2%) 17,280

Commission (960,000x4%) 38,400

Total 55,680

Less: cost of management (51,840x1/12) (4,320)

Bad debts (960,000x4%) (9,600)

Net factoring service 41,760

FOR BOCM BANK

Interest rate (864,000x18%x1/12) 12,960

Processing fee (960,000x2%) 19,200

Cost of management 4,320

Bad debts 9,600

Net cost for factoring service 46,080

Therefore, AJEX LTD should accept factoring services from ABM LTD as it has lower resulting cost
compared to BOCM Bank which has high costs.

QN 5(C):
Workings
Proposed policy= 2,880,000+80,000
= 2,960,000
Total cost other than bad debts and cash discount= 70% of credit sales
Current policy= 2,880,000x70%
= 2,016,000
Proposed policy= 2,960,000x70%
= 2,072,000
Opportunity cost of investment = Total cost +collection period x Rate of return
360 100
Current policy = 2,016,000 x ( 30/360)x(10%-(10%/2)0
= 8,400
Proposed policy = 2,072,00x(20/360)x(10%-(10%/2)
= 5,756
Cash discount = Total credit sales x % of customers who take discount x Rate/100
= 2,960 x 2% = 35,520
Profit before tax,
Current policy = 2,880,000-(2,016,000+57,600)
= 806,400
Proposed policy = 2,960,000-(2,072,000+59,200+35,520)
= 793,280
DEBTORS EVALUATION POLICIES
Particulars Current policy Proposed policy
Credit sales 2,880,00 2,960,000
Total cost other than bad debts and cash discount (2,016,000) (2,072,000)
Bad debts (57,600) (59,200)
Cash discount (35,520)
Profit before tax 806,400 793,280
Less: tax (30%) (241,920) (237,984)
Profit after tax 564,480 555,296
Less: Opportunity cost of investment (8,400) (5,756)
Net benefit 556,080 549,540

Therefore, the company should not change the credit policy, because current policy has high net benefit of Tzs
556,080 than that of proposed currency which has low net benefit of Tzs 549,540.

QN 6(A):
Receivable management involves overseeing the process of collecting payments owed to a company for goods
or services provided. Since not all goods are sold on cash other are sold on credit where by in order to credit a
customer it involves Assessing the creditworthiness of potential customers in receivable management involves
evaluating their ability and willingness to pay, it is done as follows
Financial Statements, Analyze the customer's financial statements, including balance sheets, income
statements, and cash flow statements.This helps in understanding their financial health, liquidity, and
profitability, indicating their ability to meet payment obligations.
Bank References, Obtain references from the customer's bank to verify their financial stability and banking
history. Banks can provide information on the customer's average account balances, overdraft history, and
overall financial conduct.
Trade References, Contact other businesses that have previously extended credit to the customer. Trade
references can provide valuable information about the customer's payment habits, reliability, and any past
issues with late payments or defaults.
Public Records, Check public records for any legal issues such as bankruptcies, liens, or judgments against the
customer.This can highlight potential risks and past financial troubles that might affect their ability to pay.
Internal Data, Use any existing internal data on the customer's payment history if they have previously done
business with your company. Past performance can be a strong indicator of future behavior.
Credit Reports, Obtain credit reports from reputable credit rating agencies includingTrans Union to assess the
customer's credit history and score. These reports provide insights into the customer's past payment behavior
and financial reliability.
QUESTION 6(B):

6 a. Calculation of Benefits and Costs of the Offer

Current Situation:

Credit Sales per Year: TZS 1,337,500,000

Credit Terms: 40 days

Bad Debts: 1.2% of credit sales

Trade Receivables: TZS 222,900,000

Cost of Short-term Finance: 5% per year

Proposal by KG Co.

Reduced Collection Period: 36 days

Reduction in Bad Debts: 75%

Reduction in Administration Costs: TZS 2,500,000 per year

Advance Rate: 80% of the value of invoices

Interest Rate on Advances: 8% per year

Annual Fee: 0.70% of credit sales

Current Bad Debts:

Bad Debts

=1.2% ×1,337,500,000

=𝑇𝑍𝑆16,050,000

Bad Debts After Factoring:

Reduction in Bad Debts=75%×16,050,000=TZS12,037,500

New Bad Debts=16,050,000−12,037,500=TZS4,012,500

Trade Receivables with New Average Collection Period:

New Trade Receivables

(1,337,500,000 ÷ 360) × 36

=TZS133,750,000

Reduction in Trade Receivables:

Reduction =222,900,000−133,750,000=TZS89,150,000

Annual Savings on Financing Costs:

Savings =5%×89,150,000= TZS4,457,500

Cost of Factoring:

Factoring Fee=0.70%×1,337,500,000= TZS9,362,500

Interest on Advance:

Advance Amount=80%×133,750,000= TZS107,000,000

Interest=8%×107,000,000=TZS8,560,000

Total Costs of Factoring:

Total Cost=Factoring Fee+Interest=9,362,500+8,560,000=TZS17,922,500

Total Savings:

Total Savings=Reduction in Bad Debts+Savings on Financing Costs+Reduction in Admin Costs

=12,037,500+4,457,500+2,500,000=TZS18,995,000

Net Benefit:

Net Benefit=Total Savings−Total Costs

Based on the calculations:

Total Costs of Factoring: TZS 17,922,500

Total Savings from Factoring: TZS 18,995,000

Net Benefit: TZS 1,072,500

Recommendation: The net benefit of TZS 1,072,500 indicates that accepting KG Co.'s offer is financially
acceptable for ABC Co. as it results in a positive net benefit.

6 b. Additional Benefits of Factoring services which ABC Company will benefit are;

Improved Cash Flow and Liquidity:

By advancing 80% of the invoice value, KG Co. provides immediate cash to ABC Co. This can significantly
improve the company's cash flow and liquidity position, enabling ABC Co. to meet its short-term obligations
more effectively, invest in growth opportunities, and reduce reliance on short-term borrowing.

Reduced Administrative Burden:

Factoring services typically include credit control, collections, and ledger management. By outsourcing these
functions to KG Co., ABC Co. can reduce its administrative workload and associated costs beyond the
specified TZS 2,500,000. This allows the company to focus more on its core business activities, such as sales
and customer service, potentially leading to higher efficiency and productivity.

Conclusion; factoring can provide strategic benefits by enhancing cash flow, improving liquidity, and allowing
ABC Co. to concentrate on growth and operational efficiency, in addition to the direct financial benefits
calculated.

QN 7 (a)

Workingcapitalcycle=Inventorydays+tradereceivablesdays-tradepayablesdays

(i).Inventory days=365×Inventory days/cost of sales

Inventory days = 365 x (5,700/26,000) = 80 days

(ii).Trade receivables days= 365×Average accounting receivables/Credit sales

Trade receivables days = 365 x (6,575/40,000) = 60 days

(iii).Trade payable= 365× Average accounting payable/credit purchases

Trade payables days = 365 x (2,137/26,000) = 30 days

Working capital cycle of CSZ Co = 80 + 60 – 30 = 110 days

The working cycle of CSZ Co is positive and the company pays its trade suppliers 110 days (on average) before it receives
cash from its customers. This represents a financing need as far as CSZ Co is concerned, which could be funded from a
short-term or long-term source.

A positive working capital cycle indicates that the company takes longer to convert its investments in inventory and
accounts receivable into cash, which might imply inefficiency in managing working capital.

If the working capital cycle had been negative, CSZ Co would have been receiving cash from its customers before it
needed to pay its trade suppliers. A company which does not give credit to its customers, such as a supermarket chain,
can have a negative working capital cycle.
Even if companies might generally prefer to be paid by customers before they have to pay their suppliers, the question
of whether the working capital cycle should be positive or negative implies that companies are able to make such a
choice, but this is not usually the case.

This is because the length of the working capital cycle depends on its elements, which are inventory days, trade
receivables days and trade payables, and these elements usually depend on the nature of the business undertaken by a
company and the way that business is conducted by its competitors. The length of the working capital cycle is usually
therefore similar between companies in the same business sector, but can differ between business sectors

QN 7(B)
DATA GIVEN
Credit sales of March 2015 $ 40 million

Cost of sales $ 60% of sales

Inventory days= 60days

Trade receivable=75

Trade payable=55

Current ratio=1.4

Target quick ratio=current assets –inventory/current liability

First will need to find the current assets and current liability

Current assets = inventory +trade receivable

But inventory we don’t have

Inventory days=inventory/cost of sales*365

60days=inventory/$40,000,000*0.6

60days=inventory/24,000,000

60*24,000,000/365

1,440,000,000/365

Inventory=$ 3,945,205.479

Trade receivable days=trade receivable/sales*365

75days=trade receivable/$40,000,000

75days*$40,000,000=365days
$3,000,000,000/365

Trade receivable= $8,219,178.082

So the current assets=3,945,205.479+8,219,178.082

Total current assets=$12,164,383.56

Current liability=trade payable + overdraft

Trade payable days=trade payable/cost of sales*365

55days=trade payable/$24,000,000*365

55days*$24,000,000/365days

1,320,000,000/365

Trade payable =$3,616,438.356

But to get the overdraft let use this formula

Current asset=current ratio*current liability

12,164,383.56=1.4*(trade payable +overdraft)

12,164,383.56=1.4*(3,616,436.356+0verdraft)

12,164,383.56=5,063,013.699+overdraft

12,164,383.56-5,063,013.699=1.4overdraft

Overdraft=7,101,369.861/1.4

Overdraft=5,072,407.044

Current liability=5,072,407.044+3,616,436,356

Total current liability=8,688,843.4

From the formula of target quick ratio

Target quick ratio= 12,164,383.56-3,945,205.479/8,866,845.4

Target quick ratio=0.94

(b) To find the target ratio of sales to net working capital of CST Co at the end of March 2015

Target ratio of sales to net working capital = sales / net working capital
Net working capital=current asset-current liability

NWC=12,164,383.56-8,688,845.4

NWC=3,475,540.16

Target ratio of sales to net working capital=$40,000,000/$3,475,540.16

Target ratio of sales to net working capital is 11.50

QN 7(C):

ThecurrentliabilitiesattheendofMarch2015,calculatedinpart(b),canbedividedintotradepayablesandtheforecastove
rdraftbalance.

Tradepayablesusingtargettradepayablesdays=24,000,000x55/365=$3,616,438.

The overdraft (balancing figure)=8,688,846–3,616,438=$5,072,408

Comparing current assets and current liabilities:

At the end of march 2014 At the end of march 2015

Overdraft as percentage of (4682000/6819000)×100% (5072408/8688846)×100%

current liabilities fall from 69% =69% =58%
to 58%

Current liabilities are expected to 8,688,846 6,819,000

increase by
27.4%=(8688846/6819000)×100

Trade payables rise by 69.2% 2,137,000 3,616,438

= (3,616,438/2,137,000)×100%

Trade payables days increased 30 days 55 days

Current assets fall to 99% 12,275,000 12,164,384

 =(12,164,384/12,275,000)×100
%

Trade receivables rise by 25% 6,575,000 8,219,178

= (8,219,178/6,575,000)×100%

Trade receivables days increased 60 days 75 days

Change in Working Capital Financing policy:

At the end of march 2014 At the end of march 2015

Current liabilities is 56% of Current liabilities is 71% of

Current asset current asset.
=(6,819,000/12,275,000)×100% =(8,688,846/12,164,384)×100%
Suggesting that 44% of current Suggesting that 29% of current
asset financed from a long term asset financed from long term
source source

Therefore, this increasing reliance on short term finance implies change in the working capital financing policy
of CSZ Co.