(2)Liquidity ratios Current ratio=current assets/currents liabilities Normally,current ratio 2 is preferable;however,it depends on what industries the company is in. Quick ratio(acid test ratio) =(Current assets-inventories)/current liabilities With slow inventory turnover,it is better>I With quick inventory tumnover,it can< Accounts receivables payment period (approximate) =(Trade receivables/credit sales revenue)x365 days Inventory turnover period=(Average inventory cost of sales)x365 days WIP production period=average WIP/cost of salesx365 days Raw materials inventory holding period =average raw materials inventory/annual purchasesx365 days Accounts payable payment period =(Average trade payables/purchase or cost of sales)x365 days (3)overtrading Over-capitalization VS overtrading Prudent policy in finance VS aggressive policy Exam focus Diagnose overtrading/overcapitalization Suitable solutions to reduce the degree of overtrading -The introduction of new long-term capital -Improve working capital management efficiency (better control could be applied to inventories and accounts receivable) -Abandon ambitious plans for increased sales and more non-current asset purchases 2.基本概念和知识点 Over capitalisation-too slowly -Working capital turnover period long -Liquidity ratio increase Over trading-too quickly develop with little long-term capital -Rapid increase in turnover -Rapid increase in current assets -Increase in creditor/overdraft -Small increase in equity,more increase in current liabilities -Liquidity ratios fall,even liquid deficit
（2）Liquidity ratios ◆ Current ratio=current assets/currents liabilities Normally, current ratio 2 is preferable; however, it depends on what industries the company is in. ◆ Quick ratio (acid test ratio) = (Current assets-inventories)/current liabilities With slow inventory turnover, it is better >1 With quick inventory turnover, it can <1 ◆ Accounts receivables payment period (approximate) = (Trade receivables/credit sales revenue) ×365 days ◆ Inventory turnover period= (Average inventory / cost of sales) ×365 days WIP production period=average WIP/ cost of sales×365 days Raw materials inventory holding period = average raw materials inventory/annual purchases×365 days ◆ Accounts payable payment period = (Average trade payables/purchase or cost of sales) ×365 days （3）overtrading Over-capitalization VS overtrading Prudent policy in finance VS aggressive policy Exam focus – Diagnose overtrading/overcapitalization Suitable solutions to reduce the degree of overtrading – The introduction of new long-term capital – Improve working capital management efficiency (better control could be applied to inventories and accounts receivable) – Abandon ambitious plans for increased sales and more non-current asset purchases 2. 基本概念和知识点 Over capitalisation – too slowly – Working capital turnover period long – Liquidity ratio increase Over trading – too quickly develop with little long-term capital – Rapid increase in turnover – Rapid increase in current assets – Increase in creditor/overdraft – Small increase in equity, more increase in current liabilities – Liquidity ratios fall, even liquid deficit
3.问题与应用（能力要求） Over capitalisation和Over trading各自的特点和成因 第二节 1.主要内容 (1)Managing working capital optimum order quantities for inventory The assumptions of EOQ Demand and lead time are constant and known Purchase price is constant No buffer inventory held(not needed) EOQ-economic order quantity=(2CoD/Ch) Co ordering costs(per order D- expected annual demand Ch- -holding cost per stock unit per annum Total annual cost of stock=holding cost+reordering cost =(average stock x Ch)+(Number of reorders pa x Co) Average stock=EOQ/2,no buffer stock Number of reorders (it can be not an integer)=D/EOQ Period cost Holding costs Reorder costs E00 Reorder() Decision of order size between EOQ and bulk discount How to determine -compare the total costs and choose the cheapest one Average stock=Q/2+buffer stock If bulk purchase discounts are available the impact of these on total inventory related costs needs need to be assessed. Total costs=purchase costs+holding costs+reordering costs Example 1 The annual demand for an item of stock is 125 units.The item costs f200 a unit to purchase,the holding cost for I unit for I year is5%of the unit cost and ordering costs are f300 an order.The supplier offers a3%discount for order of60 units or more,and a discount of 5%for orders of 90 units or more.What is the cost-minimising order size?
3.问题与应用（能力要求） Over capitalisation 和Over trading 各自的特点和成因。 第二节 1. 主要内容 （1） Managing working capital optimum order quantities for inventory The assumptions of EOQ ✓ Demand and lead time are constant and known ✓ Purchase price is constant ✓ No buffer inventory held (not needed) EOQ-economic order quantity = (2CoD/Ch) ½ Co ---------- ordering costs (per order) D --------- expected annual demand Ch--------- holding cost per stock unit per annum Total annual cost of stock= holding cost + reordering cost =(average stockｘCh)+( Number of reorders paｘCo) Average stock=EOQ/2, no buffer stock Number of reorders (it can be not an integer) = D/ EOQ Decision of order size between EOQ and bulk discount How to determine -----compare the total costs and choose the cheapest one Average stock=Q/2+buffer stock If bulk purchase discounts are available the impact of these on total inventory related costs needs need to be assessed. Total costs= purchase costs+ holding costs+ reordering costs Example 1 The annual demand for an item of stock is 125 units. The item costs £200 a unit to purchase, the holding cost for 1 unit for 1 year is 15% of the unit cost and ordering costs are £300 an order. The supplier offers a 3% discount for order of 60 units or more, and a discount of 5% for orders of 90 units or more. What is the cost-minimising order size?
EOQ ignoring discount is (2+300*125/200x15%)=50 units Purchase c0st125*200=25000 Ordering cost 2.5*300=750 Holding cost(50/2)*30=750 Total costs=26500 60 units per order @3%discount Purchase cost 25000*(1-3%)=24250 Ordering cost (125/60)◆300-625 Holding cos (60/2)*15%*200*97%=873 Total costs=25748 90units per order@5%discount Purchas cost 25000*95%=23750 Ordering cost (125/90)*300=416.7 costs=25 449.1 The cheapest option is 90 units per order Just-in-time procurement The definition of JIT JIT is a work flow organization technique to allow rapid,high quality,flexible production whilst minimizing stock levels and manufacturing waste No stock Benefits: Reducing stockholding cost Reduction in accounting/admin cost Reduced scrap/rework/warranty cost Reducing manufacturing lead times Improved productivity Improved the supplier relationship -Drawbacks Not easy to build such a system,it spend TOYOTA about 25 years to run JIT successful It is not suitable for all industries Dependent on quality and reliability Long-term trusting relationships √Physical proximity Increase the risk of not being able to meet demand due to production problems or because of unexpected increases in demand. Example 2 Hexicon plc manufactures and markets automatic washing machines.Among the many hundreds of components which it purchase each year from extemal suppliers fo assembling into the finished article are drive belts.of which it uses 40.000 units pa.It is
EOQ ignoring discount is (2*300*125/200×15%)½ =50 units Purchase cost 125*200=25000 Ordering cost 2.5*300=750 Holding cost (50/2)*30=750 Total costs=26500 60 units per order @ 3% discount Purchase cost 25000*(1-3%)=24250 Ordering cost (125/60) *300=625 Holding cost (60/2)*15%*200*97%=873 Total costs=25748 90 units per order @ 5% discount Purchase cost 25000*95%=23750 Ordering cost (125/90)*300=416.7 Holding cost (90/2)*15%*200*95%=1282.5 Total costs=25449.2 The cheapest option is 90 units per order Just-in-time procurement The definition of JIT JIT is a work flow organization technique to allow rapid, high quality, flexible production whilst minimizing stock levels and manufacturing waste. – No stock Benefits: ✓ Reducing stockholding cost ✓ Reduction in accounting/admin cost ✓ Reduced scrap / rework/warranty cost ✓ Reducing manufacturing lead times ✓ Improved productivity ✓ Improved the supplier relationship –Drawbacks ✓ Not easy to build such a system, it spend TOYOTA about 25 years to run JIT successful ✓ It is not suitable for all industries. ✓ Dependent on quality and reliability ✓ Long-term trusting relationships. ✓ Physical proximity ✓ Increase the risk of not being able to meet demand due to production problems or because of unexpected increases in demand. Example 2 Hexicon plc manufactures and markets automatic washing machines. Among the many hundreds of components which it purchase each year from external suppliers for assembling into the finished article are drive belts, of which it uses 40,000 units pa. It is
considering converting its purchasing,delivery and stock control of this item to a just- in-time system.This will raise the number oforders placed but lower the administrative and other costs of placing and receiving orders.Details of actual and expected ordering and carrying costs are given in the table below. Actual Proposed Ordering cost per order 3100$25 Purchasing cost per item $2.50 $2.50 Inventory holding cos 20%20%(as a percentage of the purchase cost) To implement the new arrangements will require 'one-off reorganization costs estimated at $4,000 which will be treated as a revenue item for tax purposes.The rate of corporation tax is33%and Hexicon can obtain finance at 12%The effective life span of the new system can be assumed to be 8 years. (i)Determine the effect of the new system on EOQ; (ii)Determine whether the new system is worthwhile in financial terms 0 Present E0Q=(2CDH)-[2x$100x40,000M20%x$2.50) =4,000 units /order Proposed E00=【2xs25X40,00M20%xs2,501=2,000 units/order from this it can be seen that the EOQ is halved. (m）First step holding cost reduced=(4,000/2-2,000/2)x $2.5x20%=$500 reordering cost reduced=40,000/4,000 x $100-40,000/2,000 x $25 =$500 Total inventory cost reduced=1,000(before tax) Considering tax shield,total inventory cost reduced=$1,000 x 67%=$670 Second step:calculate NPV Cash Discount Present flow factor value 1-8 after tax savings $670 4.968 $3,329 0 cost of reorganization (4,000)1.000 (4,000) 0 tax saving (again tax shield) 1,320 1.000 1320 Net Present Value 649 As NPV is positive,this proposal is worthwhile (2)Management of accounts receivables Receivables
considering converting its purchasing, delivery and stock control of this item to a justin-time system. This will raise the number of orders placed but lower the administrative and other costs of placing and receiving orders. Details of actual and expected ordering and carrying costs are given in the table below. Actual Proposed Ordering cost per order $100 $25 Purchasing cost per item $2.50 $2.50 Inventory holding cost 20% 20% (as a percentage of the purchase cost) To implement the new arrangements will require ‘one-off’ reorganization costs estimated at $4,000 which will be treated as a revenue item for tax purposes. The rate of corporation tax is 33% and Hexicon can obtain finance at 12%. The effective life span of the new system can be assumed to be 8 years. (i) Determine the effect of the new system on EOQ; (ii) Determine whether the new system is worthwhile in financial terms. (i) Present EOQ =(2CD/H) ½=[(2ｘ$100ｘ40,000)/(20%ｘ$2.50)] ½ = 4,000 units /order Proposed EOQ = [(2 ｘ $25 ｘ 40,000)/(20% ｘ $2.50)] ½ = 2,000 units/order from this it can be seen that the EOQ is halved. (ii) First step: holding cost reduced=(4,000/2-2,000/2)ｘ $2.5ｘ20% =$500 reordering cost reduced=40,000/4,000ｘ$100-40,000/2,000ｘ$25 =$500 Total inventory cost reduced=$1,000 (before tax) Considering tax shield, total inventory cost reduced=$1,000ｘ67%=$670 Second step: calculate NPV Cash Discount Present flow factor value 1-8 after tax savings $670 4.968 $3,329 0 cost of reorganization (4,000) 1.000 (4,000) 0 tax saving (again tax shield) 1,320 1.000 1,320 Net Present Value 649 As NPV is positive, this proposal is worthwhile. （2） Management of accounts receivables Receivables
management requires a 4-step approach 1.A receivables policy (whetherto offer credit,what terms to offer) 2.A credit analysis system(references,credit ratings) 3.A credit control system(review ofcredit limits) 4.A debt collection system(statements,reminders,debt factor) Credit policy Cost of credit control--interest,management cost,implemental cost Risk of credit--bad debt Higher receivables can be investments that help to boost future cash flows but cause higher finance(overdraft)costs. Extension of credit (cost-benefit analysis) The profitability of the extra sales √The safety The required rate of retu on the investment in additionalaccounts receivable Competition situation Financing costs and costs of credit control Example 3 Enticement Co currently expects sales of 50.000 a month.variable costs of sales are 40,000 a month.It is estimated that if the credit period allowed to accounts receivable were to be increased from 30 days to 60 days,sales volume would increase by 20%.All customers would be expected to take advantage of the extended credit.If the cost of capital is 12.5%ayear,is the extension of the credit period justifiable in financial terms? Solution: After credit extension.accounts receivable 50000 x (1+20%)x 2=120000 Current A/R=50000 Increased A/R=70000 Additional annual profits =10000x20%x12=24000 Benefits=24000-70000x12.5%=15250 So,the extension of credit period is acceptable Early settlement discounts Objective---shorten the credit periods,use money more efficient and reduce interest cost Advantages: Reducing in interest cost,management costs Potential to reduce the irrecoverable debts arising Offers a choice to customers of payment terms Disadvantages:
management requires a 4-step approach 1. A receivables policy (whether to offer credit, what terms to offer) 2. A credit analysis system(references, credit ratings) 3. A credit control system(review of credit limits) 4. A debt collection system (statements, reminders, debt factor) Credit policy ✓ Cost of credit control -- interest, management cost, implemental cost ✓ Risk of credit -- bad debt ✓ Higher receivables can be investments that help to boost future cash flows but cause higher finance (overdraft) costs. Extension of credit (cost-benefit analysis) ✓ The profitability of the extra sales ✓ The safety ✓ The required rate of return on the investment in additional accounts receivable ✓ Competition situation ✓ Financing costs and costs of credit control Example 3 Enticement Co currently expects sales of 50,000 a month, variable costs of sales are 40,000 a month. It is estimated that if the credit period allowed to accounts receivable were to be increased from 30 days to 60 days, sales volume would increase by 20%. All customers would be expected to take advantage of the extended credit. If the cost of capital is 12.5% a year, is the extension of the credit period justifiable in financial terms? Solution: After credit extension, accounts receivable = 50000 x (1+20%) x 2=120000 Current A/R = 50000 Increased A/R = 70000 Additional annual profits = 10000 x 20% x 12=24000 Benefits = 24000- 70000 x 12.5% =15250 So, the extension of credit period is acceptable. Early settlement discounts Objective ---shorten the credit periods, use money more efficient and reduce interest cost Advantages: ◆ Reducing in interest cost, management costs ◆ Potential to reduce the irrecoverable debts arising ◆ Offers a choice to customers of payment terms Disadvantages: