Work-Based Assignment: The Case of XYZ Limited
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Work-Based Assignment: The Case of XYZ Limited
The Cash Operating Cycle
The cash operating cycle= the inventory period plus the accounts receivables period.
Where:
- Inventory period: refers to the amount of time the inventory will sit in store until they get sold.
- Accounts receivable period: Refers to the time it takes to acquire money from the sale of the sitting inventory.
If materials represent 50% of the total cost of sales, they amount to 5,600,000 divided by 2, which amounts to 2,800,000.
Days Inventory Outstanding (DIO): (550000+220000+350000+210000) = (1,330,000/2,800,000) by 365.
Equals 173.375 days
Days Sales Outstanding (DSO): (506000/1,400,000) by 365
Equals 131.9 days
Operating cycle= 173.375 plus 131.9
The operating cycle is 305.275 days.
Methods of Reducing the Cash Operating Cycle
One approach to reducing the cash operating cycle is by eliminating excess inventory. Common knowledge dictates that inventory that sits for a long time without moving or being sold prolongs the time taken for cash conversion (Sagner, 2015). Therefore, businesses must optimize their inventory. Businesses that are able to move inventory efficiently and acquire only what they require tend to keep the cash operating cycle at a manageable level (Sagner, 2015). One way to optimize inventory is by purchasing and integrating inventory management software into the business. The software should assist the business in keeping track of raw materials, finished products, sales trends, and other key performance indicators for the cash operating cycle.
Enhanced forecasting will facilitate better inventory management. According to Tsounis and Vlachvei (2020), forecasting helps businesses have as much inventory as they need on hand. The early acquisition of inventory during a low season or stockpiling during high demand can backfire, reducing liquidity due to the cash held by the unsold items. Such a scenario explains why having detailed and reliable forecasts is critical in business. A firm comprehension of what the audience needs will help aligning marketing and purchasing efforts. Forecasting implies that a business must conduct periodic market assessments, whose results will be applied to adjust the inventory.
While encouraging prompt customer payments might adversely affect the customer experience and overall satisfaction, it will reduce the cash operating cycle. Large enterprises should ensure they have payment systems that send invoices immediately to consumers (Sagner, 2015). Automated software can be used to send invoices and follow up on payment deadlines. The invoices should be clear on how much is owed and when. A payment collection process should begin immediately when clients delay payments. An enterprise can incentivize customers to pay early by offering better rates and rewards.
The integrated payment system should have options that make it easy and convenient for customers to make payments. The payment system should use simplified invoices (Tsounis & Vlachvei, 2020). Management should work with the receivable team to decide on which information should be included in their invoice. The design of the sheet should be easy to navigate to negate any confusion regarding how or when to pay. Secondly, having multiple payment options allows customers to choose the best method for their comfort. Enhanced convenience will translate in early payments.
Forecasting, inventory management, and market analysis imply that businesses should invest in real-time analytics to reduce the cash operating cycle. Cash flows are bound to change consistently throughout the course of the financial quarter (Sagner, 2015). Real-time analytics provide timely, reliable, and accurate information on key performance indicators. The result is improved decision-making for the organization. However, the effectiveness of real-time analytics will depend on a company having the right personnel to interpret and apply the information. Having competent individuals to execute a well-designed financial strategy will reduce the cash operating cycle. Such a requirement will, however, increase the operational costs of the firm through heightened wages and salaries for individuals keeping track of the cash operating cycle.
The Significance of Trade Payables
Trade payables refer to money an enterprise owes for the goods and services acquired through credit. A company will owe this sum to vendors, suppliers, and third-party agents. Any amount paid to the suppliers immediately in cash does not comprise part of the trade account payables (Godlove, Rene & Feudjo, 2020). The payables can be written in the balance sheet as current or non-current liabilities, depending on how the enterprise plans to address its debts. If an organization is used to applying accrual accounting, then the trade payables can be recorded in their full value, including discounts (Godlove, Rene & Feudjo, 2020). If cash accounting is applied, then only a segment of the trade payables is recorded as due when acquiring a product or service. Important to note is that the payment of trade payables differs from company to company (Godlove, Rene & Feudjo, 2020). Some include flexible payments of a month, 60, or 90 days. As a result, businesses must maintain accurate balance sheets.
There are numerous reasons why a company would want to track its trade payables. Foremost, the owed money impacts the business’ cash flow management. The optimal tracking of trade payables enhances financial awareness within the firm since the accounting is done on a daily basis (Godlove, Rene & Feudjo, 2020). Secondly, purchasing goods and services using trade payable terms enables an organization to improve its cash flow by a particular amount for a given amount of time. Therefore, if the business is facing any financial challenges, it can use the saved cash and the acquired items to nurse itself back to health (Godlove, Rene & Feudjo, 2020). The saved money can be used to cover essential expenses, such as employee salaries. Lastly, trade payables allow businesses to avert conventional bank loans. The benefit is that the business avoids lender-driven company closure or unwarranted acquisition.
Tracking trade payables will ensure management is aware of which bills are due, meaning it plays a critical role in financial planning. For instance, if a business has covered a supplier invoice, but the acquired products are still in backorder, the trade payable will inform how long the supplier will take to deliver the items (Ferrando & Mulier, 2012). Such information helps management plan, especially in preventing additional expenditure. The business also ensures it has all the required items in its inventory as it awaits delivery. The optimal planning of inventory will influence how a business maintains its supplier relationships (Ferrando & Mulier, 2012). An organized balance sheet ensures the enterprise pays its debt on time, enhancing supplier confidence in the business. In addition, it becomes easier to identify any changes or discrepancies that might impact the supplier relationship.
The Risks of Overreliance on Trade Credits
Tax credits have their advantages and disadvantages, depending on how they are planned for and used in a business. The credit given is seldom on free terms, meaning poor planning can have disastrous implications on cash flow management, among other financial functions (Pike, Neale & Linsley 2018). The most immediate negative implications would be on the cash flow. The money owed to vendors and suppliers will create a hole in the company’s inventory and cash flow. The enterprise will be forced to make payments with higher interest rates at an increased frequency. Long-term holes in the cash flow will result in the enterprise not having the goods or raw materials it requires to meet consumer demands (Pike, Neale & Linsley 2018). The owed vendor, supplier, or band that extends the credit will be forced to reconsider the company’s credit ratings. The assessment will take time, impeding the business from acquiring additional loans. In most cases, a review of creditworthiness will result in the enterprise receiving poorer terms, including lower credit amounts.
An overreliance on trade credits increases the operational costs of a firm. Extending credit will establish more outstanding accounts receivable (Pike, Neale & Linsley 2018). Therefore, the business will be required to hire an individual to keep track of the accounts, which translates to additional expenses in the form of salaries. With the possibility of heightened inflation or changed interest rate terms, the overreliance on credit increases the possibility of bad debt (Pike, Neale & Linsley 2018). Ultimately, the extension of trade credits will incentivize some debtors not to cover their debts. Late payments or complete absconding to pay can push the creditor to insolvency. As a result, businesses must offer some extended payments or collateral to remain competitive in the credit market.
References
Ferrando, A. & Mulier, K. (2012). Do firms use the trade credit channel to manage growth? European Central Bank Working Paper Series, 1502, 1-30.
Godlove, N., Rene, G. & Feudjo, R. J. (2020). Trade payable and financial performance of small and medium size enterprises. The International Journal of Business management, 8(1), 93-103.
Pike, R., Neale, B. & Linsley, P. (2018). Corporate finance and investment: Decisions and strategies. Pearson Education.
Sagner, J. (2015). Working capital management: Applications and case studies. Wiley.
Tsounis, N. & Vlachvei, A. (2020). Advances in cross-section data methods in Applied Economics. Springer International Publishing.