Question 1

The different strategies a company may follo

w in financing its cumulative working capital
requirements are the aggressive funding p
olicy and the conservative funding policy.
Aggressive policy on level of working capital
will have lower levels of investment compar
ed to that of a conservative policy.

 3 different types of a companys assets:

1. Non-current assets
Long-term assets from which a company expects
to derive benefit over several periods
(eg: factory buildings & production machinery)
2. Permanent current assets
Core level of investment needed to sustain
normal levels of business or trading activity
(eg: investment in inventories & in the average
level of a companys trade receivables.
3. Fluctuating current assets
Correspond to the variations in level of current
assets arising from normal business activity.

 Aggressive funding policy uses short-term

funds to finance fluctuating current assets a
nd some permanent current assets. It carries
the greatest risk of insolvency, but also offer
s the highest profitability and increases shar
eholder value.
Conservative funding policy uses long-ter
m funds to finance non-current assets, per
manent current assets as well as some fluctu
ating current assets. There is less reliance on
short-term funding, thus the risk of such poli
cy is lower. However, the higher cost of longterm finance means that profitability is also r

 A company having an aggressive policy will b

e able to increase its profitability as less cas
h is tied up in current assets. However, higher
risk is involved due to the higher possibility of
running out of inventory or cash shortages.
A company having a conservative policy wou
ld be associated with maintaining a larger cash
balance, for instance investing in short-term s
ecurities, offering more generous credit terms
to customers and holding higher levels of inve
ntory. Lower risk of financial or inventory prob
lems is involved, however at the expense of re
ducing profitability.

Question 2
Possible reasons of why a company might experience cash
flow problems:
1. Company is making losses
In long term, may lead to serious cash flow problems, perh
aps even liquidation/ acquisition
2. Inflation
.Historical profit may prove to be insufficient to fund the rep
lacement of necessary assets
3. Overtrading
.Supply of funds failing to meet the demand for funds within
a company
.Liquidity crisis may occur when the company is unable to m
eet its debts as they are due
.Cash has been absorbed by growth in non-current assets, i
nventory and trade receivables.

 Ways to alleviate cash flow problems:

1. Postpone non-essential capital expenditure
2. Accelerate the rate at which cash flows into t
he business
.eg: offer discounts to customers for early pa
yment, chase overdue accounts, have a sale
to clear unwanted inventory, sell investment
s bought from an earlier period
3. Take longer time to pay suppliers/ Reschedu
le loan repayments
4. Last resort: Reduce or pass a dividend paym
ent [usually seen by capital markets as sign
of financial weakness]

Question 3
There are several ways in which a company migh
t invest its short term cash surplus, which includ
e fixed deposits, certificates of deposit and T
reasury bills.
Under fixed deposits, cash can be put on depos
it with a bank to earn interest, with the interest r
ate depending on the size of the deposit, its mat
urity and the notice required for withdrawals. To
maximise return, company should obtain quotati
on from several bank before making a deposit si
nce interest rates vary between banks as they co

 Certificates of deposit are negotiable bearer secu

rities issued by banks and building societies. They a
re for amounts ranging from 100,000 to 1m and
have maturities ranging from 28 days to 5 years. At
maturity, the holder of a certificate of deposit is ent
itled to receive both principal and interest.
Treasury bills of two, three and six-month maturiti
es are issued on a discounted basis by the UK gover
nment. They are bought and sold on the discount m
arket. The yield on Treasury bills is lower than on ot
her money market instrument because of the lower
default risk associated with government borrowing.

Besides that, there are some factors which should

be considered when choosing an appropriate inve
stment method for short-term cash surplus are:
The size of the surplus, as some investment met
hods have minimum amounts
The ease with which an investment can be realis
ed
When the investment is expected to mature
The risk and yield of the investment
Any penalties which may be incurred for early li
quidation.

Question 4
New level of sales

RM1,500,000 X 115%

RM1,725,0
00

Variable costs

RM1,293,750 X 80%

RM1,035,0
00

Contribution from sales

is therefore
Proposed investment in
debtors
Current investment in
debtors
Increase in investment
in debtors
Increase in contribution

RM1,725,000
RM1,035,000
RM1,725,000 X
60/365days
RM1,500,000 X
30/365days
RM283,562
RM123,288
RM690,000
(RM1,500,000RM900,000)

RM690,0
00
RM283,5
62
RM123,2
88
RM160,2
74
RM90,00
0

New level of bad debts

RM1,725,000 X 4%

Current level of bad debts RM1,500,000 X 1%

Increase in bad debts

RM69,000 RM15,000
Additional financing costs RM160,274 X 12%

RM69,00
0
RM15,00
0
RM54,00
0
RM19,23
3
RM16,76
7

Savings by introducing
change in policy

(RM90,000RM54,000) RM19,233

Conclusion

The proposed policy change

will increase the sale,
contribution and bad debt of
the company.

Question 5
a)
RM
Current debtors

15 mil x 45/365

1,849,315

New level of
debtors:

40% x 15 mil x 30/365

493,151

Those not taking 60% x 15 mil x 45/365

discount

1,109,589

Total

1,602,740

Those taking
discount

Change in level
of debtors

1,849,315 1,602,740

246,575

Finance savings
on debtors
Decrease in bad
debts
Savings in
administration
costs

246,575 x 9%

22,192
60,000
15,000

97,192
Cost of discount
Net benefit of
proposal
Conclusion

15 mil x 40% x 1.5 %

97,192 90,000

90,000
7,192

The proposed policy change will

increase the profitability of the
company but the benefit is very
small. Thus, it is not advisable to
undertake the change.

b)
An overdraft is an agreement by a bank to allo
w a company to borrow up to a certain limit witho
ut the need for further discussion. An overdraft is
a flexible source of finance in that a company onl
y uses it when the need arises. An overdraft is tec
hnically repayable on demand, even though a ban
k is likely in practice to give warning of its intenti
on to withdraw agreed overdraft facilities.

Short-term sources are riskier than long-term sou

rces from the borrowers point of view in that they m
ay not be renewed (an overdraft is, after all, repayabl
e on demand) or may be renewed on less favourable
terms (e.g. when short-term interest rates have incre
ased). Another risk is that interest rates are more vol
atile in the short term than in the long term and this r
isk is compounded if floating rate short-term debt (s
uch as an overdraft) is used. Thus, Menendez can fin
ance its working capital needs from an overdraft but
not advisable to over rely on it.

c) Cash conversion cycle

- sum of inventory conversion period (inventory day)
and the trade receivables conversion period (trade
receivables days), less the trade payables deferral
period (trade payable days).
- Investment in working capital must be financed and
the longer the cash conversion cycle, the more capital
is tied up and higher the cost. A company could
reduce the working capital tied up by optimizing the
components of cash conversion cycle. So, for
example, shortening the inventory conversion period
could reduce the working capital requirement and
increase profitability.

d) Ways in which Menendez could use its debtors as a s

ource of finance :
i) Factoring
- offer a range of services in the area of sale administrati
on and the collection of cash due from debtors, includin
g administration of sales invoicing and accounting, coll
ection of cash due, chasing up late payers.
- may advance up to 95% of the face value of invoices b
ut will charge interest.
ii) Invoice discounting
- involves the sale of selected invoices to a third party w
hile retaining full control over the sales ledger; it is a ser
vice often provided by factoring companies.

Question 6
A company is planning to offer a discount for payment
within 10 days to its customers who currently pay
after 45 days. Only 40 percent of credit customers
would take the discount, although administrative cost
savings of RM4,450 would be gained. If credit sales,
which is unaffected by the discount, are RM1,600,000
per year and the cost of short-term finance is 8
percent, what is the maximum discount that could be
offered?

Current level of trade

receivables

RM

RM197,260

Proposed level of trade receivables

Not taking the
discount

RM118,356

Taking the discount

RM17,534

Total

RM118,356 +
RM17,534

RM135,890

Change in level of
trade receivables

RM197,260 RM135,890

RM61,370

Savings in financing
RM61,370 x 8%
costs
Administrative cost

savings
Total savings
RM4,910 + RM4,450

Calculation of maximum discount

Hence maximum

discount

RM4,910
RM4,450
RM9360

RM9,360