Question

Modern Kitchens specializes on sell prefabricated kitchens. The company has stores in all major capital cities throughout Australia. It’s been established since 2001 and has seen tremendous growth but more recently has seen several overseas competitors enter the Australian market resulting in an increase in competition. This increased competition has placed significant pressure on containing costs and drawn management’s attention to a review of working capital practices. Detailed below are relevant figures and ratios to assist you in evaluating Modern Kitchen’s working capital management.

Working Capital Ratios 2016 2017 2018 2019

Accounts Receivable Days 14.0 days 18.1 days 23.1 days 31.9 days

Inventory Days 16.0 days 19.1 days 21.9 days 25.0 days

Accounts Payable Days 14.1 days 21. days 29.0 days 37.0 days

Note: Ratios are based on assuming end year figures are the average throughout the majority of the year

Extracts from Financial Statements

Cash on hand 0.20 mill 0.15 mill .01 mill (.003 mill)

Sales – all on credit 8.1 mill 6.9 mill 8.0 mill 9.0 mill

Accounts Receivable Balance 0.3069 mill 0.3453 mill 0.5044 mill 0.7894 mill

Inventory 0.1754 mill 0.2186 mill 0.2712 mill 0.3219 mill

Cost of Goods Sold 4.0 mill 4.2 mill 4.5 mill 4.7 mill

Accounts Payable 0.1534 mill 0.2417 mill 0.3574 mill 0.4762mill

Budgeted Figures

Cash on hand 0.3 mill 0.3 mill 0.31 mill 0.32 mill

Accounts Receivable Balance 0.30 mill 0.31 mill 0.37 mill 0.38 mill

Inventory Balance 0.16 mill 0.17 mill 0.20 mill 0.21 mill

Accounts Payable 0.16 mill 0.17 mill .19 mill 0.20 mill

Accounts Receivable Terms 14 days 14 days 14 days 14 days

Accounts Payable Terms 30 days 30 days 30 days 30 days

Industry Averages

Accounts Receivable Days 14 days 14 days 15 days 16 days

Inventory Days 15 days 16 days 16 days 15 days

Accounts Payable Days 30 days 28 days 25 days 20 days

REQUIRED:

Calculate (show full workings to your answer):

(i)  the dollar value of actual net working capital each year from 2016 to 2019 for Modern Kitchens.

(ii) the duration of the operating cash cycle each year from 2016 to 2019 for Modern Kitchens.

(iii) interpret the meaning of each of the figures calculated above (40-word limit)

(a) Review Modern Kitchens’s working capital management performance utilizing calculations in (a) above and information provided such as trends / benchmark figures / industry averages and budgets (300-word limit).

(b)  Once you have analyzed their performance, provide some strategies and recommendations to assist in improving any weaknesses in working capital management referring to the management of components of working capital including cash, inventory, accounts receivable and accounts payable. As part of your recommendations identify the associated potential benefits and costs of each recommendation. (400-word limit)

Answer 1

IDs ltesm Units Formula 2016 2017 2018 2019 2 Budgeted Figures 0.31 Cash on hand 0.30 0.32 mill 0.37 Accounts Receivable Balance mill 0.31 0.21 Inventory Balance 0.16 0.17 0.20 mill 0.17 0.20 Accounts Payable 0.16 0.19 mill Accounts Receivable Terms days Accounts Payable Tems days 30 30 30 30 Budgeted Working CapitMil -Cash Acc. Receivables +Inventory Acc. Payables. 0.60 0.71 Sales Estimate Mi (365/Days Reveivables) Receivables =Working capital/Sakes 8.08 9.65 7.82 9.91 Working Capital to sales ratio 77% 7,5% 7296 7.2% 12 х % 14 Extracts from Financial Statements 15 A Cash on hand 0.20 0.15 0.01 (0.003) mill Sales all on credit 6.90 8.00 16 B 8.10 mill 0.31 17 C Accounts Receivable Balance mill 0.35 0.50 0.79 0.27 18 D 0.32 Inventory mill Cost of Goods Sold 4.00 4.20 4.50 mill 0.48 20 F Accounts Payable Working Capital Working Capital ratio 0.15 0.24 0.36 mill mill A+C+D-F 0.63 Answer (i) 21 G 0.53 0.47 0.43 5.4% % G/B 6.5% 6.8% 70% From 2016 19, working capital as a percentage of sales has been relatively flat and At component level, Average accounts receivable are hiher than budget, but is offset somewhat with higher average accounts payables. Inventory in line with budget. Answer (iii mamagenet is also poor as compared to budget. This couples with declinign cash on hand is not heatlhy and company can face liquidity issues. Answer (ii) a 24

25 26 Industry Averages (days) 16 Accounts Receivable Days days 14 14 15 28 Inventory Days days 15 16 16 15 29 Accounts Payable Days days 30 25 Cash conversion cycle daysDays Receivables Inventory Days Payable Days 30 Y 32 Working Capital Ratios Calculated Calculated Calculated Calculated 23.0 Accounts Receivable Days Days 365/(Sales/Receivables) Days -365/(COGS/Inventory) Days-365/(COGS/Acc Payables) 33 H 13.8 34 I Inventory Days 16.0 19.0 25.0 37.0 35 J Accounts Payable Days 14.0 21.0 29.0 Operating Cash Cycle DaysH+IJ 20.0 Answer (ii) 36 K 15.8 16.3 16.0 Operating Cash Cycle = Days Receivables + Inventory Days-Payable Days. From 2016-19 Cash conversion cycle has deteriorated and company is performing worse than industry average year on year and has a scope for improvement Answer (iii) 37 38 39

Answer iii b)

Modern kitchen has a scope for improving its working capital improvement at each component level

1. Inventory - Modern kitchen can benefit from better inventory management. As its inventory days is much higher than industry average, there is scope for improvement. Company can adopt leaner and lighter model. This will reduce its cost of operations

2. Acc. Receivables & Payable - Modern kitchen need to strike better terms with its Debtors, as industry players are almost 100% more efficient than modern kitchen. With better terms here, and already superior terms with its creditors, firm can almost get to a point where its working capital will be funded by market