Question 10.11: The financial statements of Freezeqwik Ltd, a distributor of...
The financial statements of Freezeqwik Ltd, a distributor of frozen foods, for the year ended 31 December last year are set out below.
| Income statement for the year ended 31 December last year | ||
| £000 | £000 | |
| Sales revenue | 820 | |
| Cost of sales | ||
| Opening inventories | 142 | |
| Purchases | \underline{568} | |
| 710 | ||
| Closing inventories | \underline{(166)} | \underline{(544)} |
| Gross profit | 276 | |
| Administration expenses | (120) | |
| Distribution expenses | \underline{(95)} | |
| Operating profit | 61 | |
| Financial expenses | \underline{(32)} | |
| Profit before taxation | 29 | |
| Taxation | \underline{(7)} | |
| Profit for the year | \underline{22} | |
| Statement of financial position as at 31 December last year | |
| £000 | |
| ASSETS | |
| Non-current assets | |
| Property, plant and equipment | |
| Property at valuation | 180 |
| Fixtures and fittings at cost less depreciation | 82 |
| Motor vans at cost less depreciation | \underline{102} |
| \underline{364} | |
| Current assets | |
| Inventories | 166 |
| Trade receivables | 264 |
| Cash | \underline{24} |
| \underline{454} | |
| Total assets | \underline{818} |
| EQUITY AND LIABILITIES | |
| Equity | |
| Ordinary share capital | 300 |
| Retained earnings | \underline{352} |
| \underline{652} | |
| Current liabilities | |
| Trade payables | 159 |
| Taxation | \underline{7} |
| \underline{166} | |
| Total equity and liabilities | \underline{818} |
All purchases and sales are on credit. There has been no change in the level of trade receivables or payables over the period.
Calculate the length of the OCC for the business and go on to suggest how the business may seek to reduce this period.
The OCC may be calculated as follows:
| Number of days |
|
| Average inventories turnover period: \frac{(Opening inventories + Closing inventories)/2}{Cost of sales}× 365 =\frac{(142 + 166)/2}{544} |
103 |
| Average settlement period for trade receivables: \frac{Trade receivables}{Credit sales}× 365 = \frac{264}{820}× 365 |
118 |
| Average settlement period for trade payables: \frac{Trade payables}{Credit purchases}× 365 = \frac{159}{568}× 365 |
(\underline{102}) |
| OCC | \underline{119} |
The business can reduce the length of the OCC in a number of ways. The average inventories turnover period seems quite long. At present, average inventories held more than three months’ sales requirements. Lowering the level of inventories held will reduce this. Similarly, the average settlement period for trade receivables seems long, at nearly four months’ sales. Imposing tighter credit control, offering discounts, charging interest on overdue accounts and so on may reduce this. However, any policy decisions concerning inventories and trade receivables must take account of current trading conditions.
Extending the period of credit taken to pay suppliers could also reduce the OCC. However, for reasons that will be explained later, this option must be given careful consideration.