Anda di halaman 1dari 8

**Cash Flows versus Accounting Profits** Case of Mr. K. Rao: How to go broke while making a profit?

On January 1, 2001, Mr. K. Rao of K. Rao & Company had Rs. 27,500, in the following form: Cash Rs. 10,000; Inventory Rs. 7,500; and Accounts Receivable Rs. 10,000 As the year progressed, his company was in fine shape. His company made a popular product, priced at Rs.10.00 per unitjust what the customers wanted. The production of this unit cost him Rs 7.50 per unit. He made a profit of Rs. 2.50 per unit. His policy was to keep an inventory of one months supply (30 days supply), make a prompt payment of his suppliers bills and he billed his own customers, 30 days net. Sales were right on target, as given below, with the sales manager predicting a steady increase every month. It felt like his lucky year. (1) In January, he produced and sold 1,000 units of his product, shipped them to his customers on 30 days net terms, collected his dues on the previous balance of Accounts Receivables and made a decent profit on sales. (2) In the month of February sales jumped as budgeted to 1,500 units. With a corresponding step-up in production to maintain his 30 days supply in inventory, he made 2000 units at a cost of Rs.15, 000. All receivables from January sales were collected. (3) March sales were even better, 2000 units. Collections are on time. Production to adhere to his policy of 30 days sales in inventory is 2500 units. Profits are increasing satisfactorily, along with the sales. (4) In April, sales jumped further by 500 units, to 2,500 units. Rao decides to publicly acknowledge the sales managers performance. He notes that his customers are also paying in time. Production is pushed up to 3,000 units now to create further challenge for the marketing team since it sounds so confident. Rao talks to the travel agency for booking him on a long awaited vacation. (5) The month of May proves that the marketing teams confidence was well placed. The company is able to make a sale of 3,000 units. The marketing department makes a recommendation to push the production during the month to 3,500 units now. Raos quick calculation tells him that the profit graph is rising. The travel agency has booked him on a vacation to Ooty for which he packs his bags and leaves. (6) Hardly three days into his vacation, he suddenly gets a call from his treasurer, Come home. We need money to run the operations. Rao cuts his holiday short, returns on May 31, and finds that there is no money at all in his cash box. His accounts books seem to have caught up with him. What do you think has happened to his business when everything seemed to be working so well all these months? Please use this space for your conceptual reasoning.

Sample Problems on Working capital: Estimating Working Capital Needs


Q.1. You are supplied with the following information for the coming year: Production for the coming year 60,000 units Finished Goods in store, 3 months Raw materials in store, 2 months consumption Production process 1 month Credit allowed by creditors, 2 months Credit allowed to Sundry debtors, 3 months Selling price per unit, Rs. 50 Raw materials, 50 % of the selling price Direct wages, 10% of the selling price Manufacturing and administrative overheads, 16% of the selling price Selling overheads, 4% of the selling price There is a regular production and sales cycle and wages overhead accrue evenly. Wages and overheads are paid in the next month of accrual. Material is introduced at the beginning of the production cycle. Conversion costs (wages, manufacturing costs, overheads) are assumed to be equivalent of 50% to determine WIP; and all sales are credit sales equivalent to the units produced. Determine the working capital requirements of the company for the coming year. Suggested Solution: (Current Asset holding period Method) In terms of the Amount. tem Volume per month Holding time Rate in Rs. Amount in Rs. 1. R.M. 5000 units 2 months 25.00 250,000.00 2. W-I-P 5000 units 1 month 31.50 157,500.00 3. F.G. 5000 units 3 months 38.00 570,000.00 4. A/R, 5000 Units 3 months 40,00 600,000.00 5. Total GWC 1,577,500.00 Support from: 1. A/P 5000 units 2 months 25.00 250,000.00 2. Wages 5000 units 1 month 5.00 25,000.00 3. Overheads 5000 Units 1 month 8.00 40,000.00 Total Support 315,000.00 NWC (GWC1,262,500.00 support) Note: Depreciation has been excluded from the above working. Similarly, the profit margin of Rs. 10/- per unit has been excluded in the working of the blockage of funds in A/R. Thus, it is truly a cash-to-cash cycle. What are the factors which influence the working capital for a business enterprise? Can you think of the same?

Q.2 The Working Capital: Calculations of the Operating Cycle. (In Number of days)

The data for the year 2005-06 for JKL Company shows the following amount in Lakhs of Rupees: Items 1. Raw Materials, Stores and Spares 2. Work-in-process 3. Finished Goods 4. Accounts Receivables 5. Accounts Payables Opening Balance 13,819.36 224.60 2,551.68 3,025.80 10,016.72 42,704.40 4,587.04 990.88 1, 40,102.24 18,269.92 2, 16,842.60 Closing Balance 16,381.64 290.00 4,130.96 4,665.28 12,349.88

6. Purchase of Raw Materials, spares & Stores 7. Manufacturing Expenses 8. Depreciation 9. Customs & Excise Duties 10. Selling, Administration & financial Expenses 11. Sales

Calculate and show the computations for the following, assuming 360 days for the year: (a) Raw Material Storage period, (b) Average Conversion or work-in-process period (c) Finished Goods storage period (d) Average Collection period (e) Average payments period (f) The Gross Operating Cycle Period (g) The Net Operating Cycle period. (h) What would be the impact on the gross operating cycle and net operating cycle if the management planned to reduce the inventory holding period by 25% across the board? Q.3 From the following data, compute the operating cycle in days: Period covered 360 days. Average period of credit allowed by suppliers 16 days Average debtors outstanding Rs. 480,000 Raw material Consumption Rs, 4,400,000 Total Production costs Rs. 10,000,000 Total cost of sales Rs. 10,500,000 Sales for the year Rs. 16,000,000 Value of the average stock maintained: Raw material Rs. 320,000 Work-in-process Rs. 350,000 Finished Goods Rs. 260,000

Q.4 Illustrative problem on operating cycle of business and impact on working capital requirements (Amount in Lakhs of Rupees):
Item 1. Purchase of Raw material (Credit) 2. Opening Raw Material Inventory 3. Closing Raw Material Inventory 4. Raw Material Consumed 5. Direct Labour 6. Depreciation 7. Other Manufacturing expenses 8. Total costs 9. Opening WIP Inventory 10. Closing WIP Inventory 11. Costs of Production 12. Opening FG Inventory 13. Closing FG Inventory 14. Costs of Goods sold 15. Selling, Adm. Expenses 16. Cost of Sales Sales and Debtors and Creditors Sales (Credit) Opening Balance A/R Closing Balance A/R Opening Balance A/P Closing Balance A/P Actual for yr. 2008 4653 523 827 4349 368 82 553 5352 185 325 5212 317 526 5003 304 5307 Projected for yr. 2009 6091 827 986 5932 498 90 704 7224 325 498 7051 526 995 6582 457 7039

6087 545 735 300 454

8006 735 1040 454 642

Requirements: (Assume a normal 365-day year for the purpose of calculations). 1. Compute RM Conversion period 2. Compute WIP Conversion period 3. Compute FG Conversion period 4. Compute Receivables Conversion period 5. Compute Payables Conversion period 6. Compute Gross Operating Cycle in days 7. Compute Net Operating Cycle in days

Solutions Q.2 Cost sheet for JKL Company


Item 1. Purchase of Raw material (Credit) 2. +Opening Raw Material Inventory 3. -Closing Raw Material Inventory 4. =Raw Material Consumed (1+2-3) 5. +Direct Labour 6. +Depreciation 7. +Other Manufacturing expenses 8. =Total costs (4+5+6+7) 9.+ Opening WIP Inventory 10.- Closing WIP Inventory 11. =Costs of Production(8+9-10) 12. +Opening FG Inventory 13. +Customs and Excise Duties 14.= COGAS (11+12+13) 15. -Closing FG Inventory 16. =COGS (14-15) 17. +Selling, Adm. Overhead Expenses 18. =Cost of Sales (16+17) Sales and Debtors and Creditors Sales (Credit) Opening Balance A/R Closing Balance A/R Opening Balance A/P Closing Balance A/P Actual for yr. 2008 42704.40 13819.36 16381.64 40142.12 00.00 990.88 4587.04 45720.04 224.60 290.00 45654.64 2551.68 140102.24 188308.56 4130.96 184177.60 18269.92 202447.52

216842.60 3025.80 4665.28 10016.72 12349.88

Q.2.

JKL Company Operating Cycle

(Rs. Lakhs, except for holding days)


Data for 2005-2006 40142.12 111.505 15100.50 135.4200 No. of Days

Items 1. Raw Material Conversion Period (a) Raw Material Consumption (b) Raw Material consumption per day (c) Average Raw Material Inventory (d) Raw Material Inventory holding days (c/b) 2. Work in Process Conversion period (a) Cost of production including Depreciation (b) Cost of production per day (c) Average Work-in-process Inventory (d) Work-in-Process Inventory holding days 3. Finished Goods Conversion period (a) Cost of Goods Sold including Depreciation (b) Cost of Goods Sold per day (c) Average Finished Goods Inventory (d) Finished Goods Inventory holding period 4. Collection period (a) Credit sales (*At Cost of Sales or Sales Price?) (b) Sales per day (c) Average Accounts Receivables (d) Accounts Receivables outstanding days 5. Credit Deferral period (a) Credit purchases (b) Purchases per day (c) Average Creditors (A/P) (d) Accounts Payables outstanding days

45654.64 126.8184 257.30 2.0200

184177.60 511.6044 3341.32 6.5310

216842.60 602.3405 3845.54 6.3843

42704.40 118.6233 11183.30 94.2757

Summary of Operating Cycle Calculations


Item 1. Inventory Conversion period (d) of (1+2+3) above 2. A/R Conversion period 3. Gross Operating Cycle (1+2) 4. Payment Deferral period 5. Net Operating Cycle (3-4) No. of Days 143.9710 6.3843 150.3553 94.2757 56.0796

Note: 1. The above computations have been based on average data for both current assets and liabilities, and 360 days in a year. Depreciation and Profits are also both included in the working.

Q.4
Items 1. Raw Material Conversion Period (a) Raw Material Consumption (b) Raw Material consumption per day (c) Average Raw Material Inventory (d) Raw Material Inventory holding days 2. Work in Process Conversion period (a) Cost of production including Depreciation (b) Cost of production per day (c) Average Work-in-process Inventory (d) Work-in-Process Inventory holding days 3. Finished Goods Conversion period (a) Cost of Goods Sold (* or At cost of sales?) (b) Cost of Goods Sold per day (c) Average Finished Goods Inventory (d) Finished Goods Inventory holding period 4. Collection period (a) Credit sales (*At Cost of Sales or Sales Price?) (b) Sales per day (c) Average Accounts Receivables (d) Accounts Receivables outstanding days 5. Credit Deferral period (a) Credit purchases (b) Purchases per day (c) Average Creditors (A/P) (d) Accounts Payables outstanding days

(Rs. Lakhs, except for holding days)


Data for 2008 4349.00 11.9150 675.00 56.65 days Data for 2009 5932.00 16.2520 906.5 55.78 days

5212.00 14.28 255.00 17.86 days

7051.00 19.32 411.50 21.30 days

5003.00 13.71 421.50 30.74 days

6582.00 18.03 760.50 42.17 days

6087.00 16.68 640.00 38.37 days

8006.00 21.93 887.50 40.47 days

4653.00 12.75 377 29.57 days

6091.00 16.69 548 34.63 days

Summary of Operating Cycle Calculations


Item 1. Inventory Conversion period (d) of (1+2+3) above 2. A/R Conversion period 3. Gross Operating Cycle (1+2) 4. Payment Deferral period 5. Net Operating Cycle (3-4) No. of Days 105.25 38.37 143.62 29.57 114.05 119.25 40.47 159.72 34.63 125.09

Note: 1. 2.

The per-day calculations are based on 365 days in a year. The average figures have been considered in the above working and not the year end data alone. Depreciation and profits are also included in the working.

Estimating the Working Capital Needs through other methods: y Ratio of Sales. (For example, 25%-35% of annual sales) y Ratio of Fixed Investment (For example, 10%-20% of Fixed capital Investment) Risk-Return Trade-off in maintaining a particular level of Current Assets: If the firm maintains excessive levels of current assets, it leads to costs of liquidity or also called as Carrying costs. These are reduced rates of return, (decline in profitability because funds remain locked up in inventory or debtors and earn nothing). Starting from a low cost at low levels of liquidity, this cost can rise significantly and become very high as liquidity levels become excessive. If the firm maintains low levels of current assets or insufficient current assets, then it may lead to costs of illiquidity or also known as shortage costs. These are increasing stock-outs, inability to meet supplier or customer demands, loss of business to competitors who may extend more credit, affecting creditworthiness adversely. These can be very high at the low levels of liquidity. The firm should try to balance these two costswith opposing characteristics of behavior--- in such a way that the total costs are minimized. This is the point of optimum level of current assets.

Anda mungkin juga menyukai