Question 6.A.21: Trader Ltd is a wholesaler of imported washing machines. The...
Trader Ltd is a wholesaler of imported washing machines. The business is partly funded by a bank overdraft and the bank is putting pressure on Trader Ltd to reduce this as soon as possible.
Sales revenue is £14.6 million a year and is all on credit. Purchases and cost of sales are roughly equal at £7.3 million a year. Current investment in the relevant working capital elements are:
| £m | |
| Inventories | 1.5 |
| Trade receivables | 3.8 |
| Trade payables | 0.7 |
Trader Ltd’s accountant believes that much of the overdraft could be eliminated through better control of working capital. As a result, she has investigated several successful businesses that are similar to Trader Ltd and found the following averages:
| Average inventories turnover period | 22 |
| Average settlement period for trade receivables | 57 |
| Average settlement period for trade payables | 55 |
How much cash could Trader Ltd generate if it were able to bring its ratios into line with those of similar businesses?
The cash that could be generated is as follows:
| £m | £m | |
| Inventories | ||
| Current level | 1.5 | |
| Target level: 7.3/365 × 22 = | 0.4 | 1.1 |
| Trade receivables | ||
| Current level | 3.8 | |
| Target level: 14.6/365 × 57 = | 2.3 | 1.5 |
| Trade payables | ||
| Current level | 0.7 | |
| Target level: 7.3/365 × 55 = | 1.1 | 0.4 |
| Total | 3.0 |