Southwood Shopmart’s Financial Analysis

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The Net Working Capital Position

Working capital= current assets-current liabilities

Current assets in the year 1997 are valued at $ 286, while current liabilities are valued at $ 79.5

Networking capital in the year 1997 is given by $ 286-$ 79.5 = $ 206.5 Net working capital.

Funding of Working Capital

The company is funding its capital by focusing on accounts payable and notes payable while at the same time reducing the amount of held cash and securities. The approach adopted by the company is called aggressive current asset financing policy which aims at minimizing the amount of cash while increasing the amount of credit. This policy is used by the company to boost its sales revenue and increase the size of account receivables.

Inventory Conversion Period and Average Receivable Collection Period

Inventory conversion period= inventory/ cost of sold goods (365)
1997 inventory conversion period= 81.0/587.59×365= 50.32 days
1996 inventory conversion period=65.5/563.9×365=42.39 days
1995 inventory conversion period=41.9/549.27×365=27.84 days

Average receivables collection period

Is worked out by formula = Average accounts receivable/annual sales/365

Average account receivable= 183.1+152.6+129.8/3= $156.17

Annual sales= $1030.79/365= 2.84

156.17/2.82 =55.38 days. This is the average receivable collection period

Cash conversion cycle for each of the years

CCC= DSO+DIO-DPO

In this case the D which represents the days will be assumed to be years

1997 DIO= average inventory/ cost of goods sold

$ 81.0/587.59= 0.14

DSO= Average account receivable/revenue per period = 183.1/52.74=3.47

DPO= Accounts payable/ Cost of goods sold

55.7/587.59= 0.095

CCC for the year 1997 =114.77 days

CCC for the year 1996 = 96.3 days

CCC for the year 1995 = 78.2 days

The Cost Of Funding Cash Conversion Period

The CCC for the year 1997= 114.7 days

The cost of funding conversion period is given by the difference between CCC and annual receivable conversion period = (114.7- 55.38)$ 1 = $ 59.40, by using credit the company would have saved the difference between cost of funding CCC and the inventory conversion period which is given by 59.40- 50.32= $ 9.08

Actions To Reduce The Need For Cash

The company can apply for credit financing from local banks and suppliers

The company can also increase the number of its securities. The company can use the line of credit in sales.

Variables of Credit Policy

The four variables which affect credit policy as indicated in the case of the company are the collection methods for all receivables employed by the credit sector of an organization, competitors respond to this by reducing the time taken in collecting receivables. The other policy is credit rating and valuation of the customer which competitors respond to by ensuring that they only work with customers who are financially stable. The next policy is control of receivables which can be done by analyzing the outstanding sales from the customers. The last credit policy is a cost attached to a collection of receivables. Competitors respond to this by reducing the number of defaults from the customers.

Annual Percentage Cost of Credit

Cost of credit is given by Discount %( 100- D %) x (360/given days for payment-days of Discount)

2 %( 100-2%)x(360/(65-30)= 2%/98x(360/35)

0.0204×10.286= 20.98% cost of credit

Comparing the COD with the cost of capital, it is evident that COD is higher than the cost of capital. 4/96 =0.0416x (360/35) = 42.8% COD, this, therefore, means that at 4% with a net of 30 the COD will be higher for the company than at 2%.

Cost of Discount

Cost of discount is given by 206.5x 8%= $ 16.52

Cost of carrying account receivable = 183.1×8/360×30= $122.05

Cost of bad debt = 8% of accounts receivables 0.08×183.1= $ 146.49

The net after-tax income is given by income before tax is $ 52.7, tax is 40% therefore Net after tax = 0.6×52.7 = $ 31.62

Financial and Expected Financial Impact

Accepting credits would enable the company to save $ 9000 per year, however, store credits would increase the cost of sales by 587.59x 5.38 = $ 3254.

Using Software To Manage Accounts Receivable

There will be a decline in account receivable by 4 % and thus increasing the cash conversion cycle of the company. This can be worked as follows; 0.04x 55.38= 2.21, 55.38-2.21= 53.7 days.

Financial Impact On 4% COD

0.0416x (360/35) = 42.8%, this will raise the cost of credit for the company. Higher cost of credit may lower credit valuation for the customers.

Credit Policy

The recommended credit policy for the company is credit rating and valuation policy which will ensure that the company only deals with customers who can pay for their debts. This policy is very important in reducing the rate of credit default among customers. It will also enable the company to easily recover its debts. The credit policy in this situation is needed to enable the organization to evaluate the creditworthiness of the various clients before they can qualify to purchase goods on credit.

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