Question 2.4: Relevant forecast information for Drago plc for next year is...
Relevant forecast information for Drago plc for next year is as follows:
| £m | |
| Operating profit | 128 |
| Depreciation to be charged in arriving at operating profit | 34 |
| At the beginning of the year: | |
| Inventories | 15 |
| Trade receivables | 24 |
| Trade payables | 18 |
| At the end of the year: | |
| Inventories | 17 |
| Trade receivables | 21 |
| Trade payables | 19 |
The following further information is available about forecast payments during next year:
| £m | |
| Taxation paid | 32 |
| Interest paid | 5 |
| Dividends paid | 9 |
The projected operating cash flows can be derived as follows:
| £m | £m | |
| Operating profit | 128 | |
| Depreciation | 34 | |
| Decrease in working capital* | ||
| Increase in inventories (17 – 15) | (2) | |
| Decrease in trade receivables (21 – 24) | 3 | |
| Increase in trade payables (19 – 18) | \underline{1} | \underline{2} |
| Operating cash flows | 164 | |
| Interest paid | (5) | |
| Taxation paid | (32) | |
| Dividends paid | \underline{(9)} | |
| Net cash flows from operations | \underline{118} |
* Working capital is a term widely used in accounting and finance, not just in the context of projected financial statements. We shall encounter it several times in later chapters.
As we can see, there will be a decrease in working capital (that is, current assets less current liabilities) as a result of trading operations. We saw that an additional £2 million will go into increased inventories and that this will have an adverse effect on cash. However, more cash will be received from trade receivables than sales revenue generated. Similarly, less cash will be paid to trade payables than purchases of goods and services on credit.
Both of these will have a favourable effect on cash. The net effect, therefore, is a projected decrease in working capital investment leading to an increase in cash of £2 million.