Chapter 7 - Working Capital Management

Chapter 7
Working Capital Management
Question 1 -
The following data are available for Gama Limited.
Particulars 1995 (₹ In Lakhs)
Opening Balance of
a) Raw materials, stores etc. 80
b) Work-in-Progress 20
c) Finished goods 90
d) Book debts 140
e) Trade Creditors 80
Closing Balance of
a) Raw materials, stores etc. 85
b) Work-in-Progress 24
c) Finished goods 100
d) Book debts 150
e) Trade Creditors 105
Purchase of Raw materials, Stores etc. 300
Consumption of Raw materials, Stores etc. 295
Manufacturing expenses 145
Depreciation 20
Quality control cost 60
Administration & Financial and Selling costs 80
Sales 800
Required: Calculate the duration of:
(i) Raw materials and stores storage period.
(ii) Work-in-Progress period.
(iii) Finished goods storage period.
(iv) Debtors collection period.
(v) Creditors payment period, and
(vi) Operating cycle.

Question 2 -
The following data relating to a consumer goods manufacturing Firm is available for the year ended 31st
March.
Debtors Collection Period 30 days
Advance payment to Creditors 5 days
Total Cash Operating Expenses per annum (60% of the Total Cash Operating
Expenses are due to Raw Material) ₹ 600 lakhs
Number of days Raw Materials in storage 30 days
Average Credit period from Suppliers 50 days
Conversion Process Period 12 days
Finished Goods Storage Period 45 days
Required:
1. Determine the Average Cash Working Capital needed by the Firm at any point of time during the year,
assuming that the Firm wants to carry a Cash Balance of ₹ 10 Lakhs at all the time.
2. Compute the Working Capital TurNover Rate for the year.

Question 3 - Jan 2021

The following information is provided by MNP Ltd. for the year ending 31st March, 2020:
Raw Material Storage period 45 days
Work-in-Progress conversion period 20 days
Finished Goods storage period 25 days
Debt Collection period 30 days
Creditors payment period 60 days
Annual Operating Cost ₹ 25,00,000

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 Chapter 7 - Working Capital Management

(Including Depreciation of ₹ 2,50,000)

Assume 360 days in a year.
You are required to calculate:
(i)Operating Cycle period
(ii)Number of Operating Cycle in a year.
(iii)Amount of working capital required for the company on a cost basis.
(iv)The company is a market leader in its product, and it has no competitor in the market. Based on a market
survey it is planning to discontinue sales on credit and deliver products based on pre-payments in order to
reduce its working capital requirement substantially. You are required to compute the reduction in working
capital requirement in such a scenario.

Question 4 - Study Material

Following information is forecasted by R Limited for the year ending 31st March, 2020 :
Balance as at 31st March , Balance as at 31st March ,
2020 2019
(₹ in Lakh) (₹ in lakh)
Raw material 65 45
Work in progress 51 35
Finished goods 70 60
Receivables 135 112
Payables 71 68
Annual purchases of raw 400
material
(all credit)
Annual cost of production 450
Annual cost of goods sold 525
Annual operating cost 325
Annual sales (all credit) 585
You May take one year as equal to 365 days.
You are required to CALCULATE :
(i) Net operating cycle period.
(ii)Number of operating cycles in the year.
(iii)Amount of working capital requirement .

Working Capital Forecast & Maximum Permissible Bank Finance.

Question 5 - Study Material
On 1st January, the Managing Director of Naureen Ltd. wishes to know the amount of working capital that will
be required during the year. From the following information prepare the working capital requirements forecast.
Production during the previous year was 60,000 units. It is planned that this level of activity would be
maintained during the present year. The expected ratios of the cost to selling prices are Raw Materials 60%,
Direct Wages 10% and Overheads 20%. Raw materials are expected to remain in store for an average of 2
months before issue to production. Each unit is expected to be in process for one month, the raw materials
being fed into the pipeline immediately and the labour and overhead costs are 50% complete. Finished goods
will stay in the warehouse awaiting dispatch to customers for approximately 3 months. Credit allowed by
creditors is 2 months from the date of delivery of raw materials. Credit allowed to debtors is 3 months from
the date of dispatch. Selling price is ₹ 5 per unit. There is a regular production and sales cycle. Wages and
overheads are paid on the 1st of each month for the previous month. The company normally keeps cash in
hand to the extent of ₹ 20,000. Solve by A. Total approach and B. Cash cost approach.

Question 6 - Mtp April 2021

Kady Ltd. sells goods at a uniform rate of gross profit of 20% on sales including depreciation as part of cost of
production. Its annual figures for the year ending 31st March 2021 are as under:
Particulars (₹)

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 Chapter 7 - Working Capital Management

Sales (at 2 months’ credit) 12,00,000

Materials consumed (Supplier's credit 2 months) 3,00,000
Wages paid (Monthly at the beginning of the subsequent month) 2,40,000
Manufacturing expenses (Cash expenses are paid – one month in arrear) 3,00,000
Administration expenses (General) (Cash expenses are paid – one month in arrear) 75,000
Selling expenses (Paid quarterly in advance) 37,500
The company keeps one month stock each of raw materials and finished goods. A minimum cash balance of ₹
40,000 is always kept. The company wants to adopt a 15% safety margin in the maintenance of working
capital.Ignore work in progress.Find out the requirements of working capital of Kady Ltd. on cash cost basis.

Question 7 - Rtp May 2021

TN Ltd. is a readymade garment manufacturing company. Its production cycle indicates that materials are
introduced in the beginning of the production phase; wages and overhead accrue evenly throughout the period
of cycle.
The following figures for the 12 months ending 31st March, 2021 are given:
Production of shirts 54,000 units
Selling price per unit ₨ 200
Duration of the production cycle 1 month
Raw material inventory held 2 month’s consumption
Finished goods stock held for 1 month
Ratio of cost to sales price
Raw materials 60%
Direct wages 10%
Overheads 20%
Credit allowed to debtors is 1.5 months and credit allowed by creditors is 1 month. Wages are paid in the next
month following the month of accrual.
In the work-in-progress, 50% of wages and overheads are supposed to be conversion costs.
Cash is to be held to the extent of 40% of current liabilities and safety margin of 15% will be maintained.
Calculate amount of working capital required for the company on cash cost basis.

Question 8 - Study Material

The following annual figures relate to XYZ Company:
Particulars Amount (₹ )
Sales (at two months credit) 18,00,000
Materials Consumed (suppliers extend two months credit) 4,50,000
Wages paid (monthly in arrear) 3,60,000
Manufacturing expenses outstanding at the end of the year (Cash expenses
are paid one month in arrear) 40,000
Total administrative expenses, paid as above 1,20,000
Sales promotion expenses, paid quarterly in advance 60,000
The company sells its products on gross profit of 25% counting depreciation as part of the cost of production.
It keeps one month’s stock each of raw materials and finished goods, and a cash balance of ₹ 1,00,000.
Assuming a 15% safety margin, ascertain the requirements of working capital requirement of the company on
cash cost basis. Ignore work-in-progress.

Working Capital Forecast of New Company

Question 9 - Rtp May 2022
PQR Ltd., a company newly commencing business in the year 2021-22, provides the following projected Profit
and Loss Account:
(₹) (₹)
Sales 5,04,000
Cost of goods sold 3,67,200
Gross Profit 1,36,800
Administrative Expenses 33,600
Selling Expenses 31,200 64,800
Profit before tax 72,000
Provision for taxation 24,000

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 Chapter 7 - Working Capital Management

Profit after tax 48,000

The cost of goods sold has been arrived at as under:
Materials used 2,01,600
Wages and manufacturing Expenses 1,50,000
Depreciation 56,400
4,08,000
Less: Stock of Finished goods
(10% of goods produced not yet sold) 40,800
3,67,200
The figure given above relates only to finished goods and not to work-in-progress. Goods equal to 15% of the
year’s production (in terms of physical units) will be in process on the average requiring full materials but only
40% of the other expenses. The company believes in keeping materials equal to two months’ consumption in
stock.
All expenses will be paid one month in advance. Suppliers of materials will extend 1 -1/2 months credit. Sales
will be 20% for cash and the rest at two months’ credit. 70% of the Income tax will be paid in advance in
quarterly instalments. The company wishes to keep ₹ 19,200 in cash. 10% must be added to the estimated
figure for unforeseen contingencies. PREPARE an estimate of working capital.

Question 10 - Study Material, Similar Rtp Nov 2022

PQ Ltd., a company newly commencing business in 2019 has the following projected Profit and Loss Account:
Particulars (₹ ) (₹ )
Sales 2,10,000
Cost of goods sold 1,53,000
Gross Profit 57,000
Administrative Expenses 14,000
Selling Expenses 13,000 27,000
Profit before tax 30,000
Provision for taxation 10,000
Profit after tax 20,000
The cost of goods sold has been arrived at as
under:
Materials used 84,000
Wages and manufacturing Expenses 62,500
Depreciation 23,500
1,70,000
Less: Stock of Finished goods 17,000
(10% of goods produced not yet sold)

1,53,000
The figure given above relate only to finished goods and not to work-in-progress. Goods equal to 15% of the
year’s production (in terms of physical units) will be in process on the average requiring full materials but only
40%.
of the other expenses. The company believes in keeping materials equal to two months’ consumption in stock.
All expenses will be paid one month in advance. Suppliers of materials will extend 1-1/2 months credit. Sales
will be 20% for cash and the rest at two months’ credit. 70% of the Income tax will be paid in advance in
quarterly installments. The company wishes to keep ₹ 8,000 in cash. 10% has to be added to the estimated
figure for unforeseen contingencies.
PREPARE an estimate of working capital. Note: All workings should form part of the answer.

Question 11 - Study Material, Rtp, Nov 98

A newly formed company has applied to the commercial bank for the first time for financing its working capital
requirements. The following information is available about the projections for the current year:
Estimated level of activity: 1,04,000 completed units of production plus 4,000 units of work-in-progress. Based
on the above activity, estimated cost per unit is:
Raw Material ₹ 80 per unit
Direct Wages ₹ 30 per unit
Overheads (Exclusive of Depreciation) ₹ 60 per unit

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 Chapter 7 - Working Capital Management

Total Cost ₹ 170 per unit

Selling Price ₹ 200 per unit
Raw materials in stock: Average 4 weeks consumption, work-in-progress (Assume 50% completion stage in
respect of conversion cost) (Materials issued at the start of the processing).
Finished goods in stock 8,000 units
Credit allowed by suppliers Average 4 weeks
Credit allowed to debtors/receivables Average 8 weeks
Lag in payment of wages Average 1 ½ weeks
Cash at banks is expected to be ₹ 25,000
Assume that production is carried on evenly throughout the year (52 weeks) and wages and overheads accrue
similarly. All sales are on credit basis only. Find out:
(i) The Net Working Capital Required;
(ii) The Maximum Permissible Bank Finance under first and second methods of financing as per Tandon
Committee Norms.

Question 12 - Rtp Nov 2021

The management of Trux Company Ltd. is planning to expand its business and consults you to prepare an
estimated working capital statement. The records of the company reveals the following annual information:
(₹)
Sales – Domestic at one month’s credit 18,00,000
Export at three month’s credit (sales price 10% below domestic 8,10,000
price)
Materials used (suppliers extend two months credit) 6,75,000
Lag in payment of wages – ½ month 5,40,000
Lag in payment of manufacturing expenses (cash) – 1 month 7,65,000
Lag in payment of Administration Expenses – 1 month 1,80,000
Selling expenses payable quarterly in advance 1,12,500
Income tax payable in four installments, of which one falls in 1,68,000
the next financial year
Rate of gross profit is 20%. Ignore work-in-progress and depreciation.
The company keeps one month’s stock of raw materials and finished goods (each) and believes in keeping ₹
2,50,000 available to it including the overdraft limit of ₹ 75,000 not yet utilized by the company.
The management is also of the opinion to make 10% margin for contingencies on computed figure.
You are required to PREPARE the estimated working capital statement for the next year.

Double Shift Working

Question 13 - Study Material
Samreen Enterprises has been operating its manufacturing facilities till 31.3.2010 on single shift working with
the following cost structure:
Particulars Per Unit (₹ )
Cost of Materials 6
Wages (out of which 40% fixed) 5
Overheads (out of which 80% fixed) 5
Profit 2
Selling Price 18
Sales during 2009-10 is ₹ 4,32,000. As at 31.3.2010 the
company held:
Stock of raw materials (at cost) ₹ 36,000
Work-in-progress (valued at prime cost) ₹ 22,000
Finished goods (Valued at total cost) ₹ 72,000
Sundry debtors ₹ 1,08,000
In view of increased market demand, it is proposed to double production by working an extra shift. It is
expected that a 10% discount will be available from suppliers of raw materials in view of increased volume of
business. Selling price will remain the same. The credit period allowed to customers will remain unaltered.
Credit availed of from suppliers will continue to remain at the present level i.e., 2 months Lag in payment
wages and expenses will continue to remain half a month. You are required to assess the additional working
capital requirements, if the policy to increase output is implemented.

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Financing of Working Capital

Commercial Paper
Question 14 - Nov 08
Discuss the meaning of Commercial Paper?
Solution 14 -
Commercial Paper (CP) is an unsecured promissory note issued by a firm to raise funds for a short period.
This is an instrument that enables highly rated corporate borrowers for short-term borrowings and provides an
additional financial instrument to investors with a freely negotiable interest rate. The maturity period ranges
from minimum 7 days to less than 1 year.

Computation of Rate of Return

Question 15 -
Mr. Big purchased a commercial paper of Entry Inc. issued for 6 months in the market for ₹ 9,61,000. The
company issued the CP with a face value of ₹ 10,00,000. Determine the rate of return which Mr. Big earns.

Question 16 - Study Material

A Factoring firm has credit sales of ₹ 360 lakhs and its average collection period is 30 days. The financial
controller estimates, bad debt losses are around 2% of credit sales. The firm spends ₹ 1,40,000 annually on
debtors administration. This cost comprises of telephonic and fax bills along with salaries of staff members.
These are the avoidable costs. A Factoring firm has offered to buy the firm’s receivables. The factor will
charge 1% commission and will pay an advance against receivables on an interest @15% p.a. after withholding
10% as reserve. ANALYSE what should the firm do? Assume 360 days in a year.

Factoring Vs Own Collection System

Question 17 - Rtp
Jaidev Ltd has total credit sales of ₹ 40 lakhs p.a. and its average collection period is 90 days. The past
experience indicates that the Bad Debt losses are around 3% of credit sales. Jaidev spends about ₹ 1,00,000
per annum on administrating its credit sales. It is considering availing the services of a Factoring Firm. It has
received offer from Uday Ltd, which agrees to buy the receivables of Company. Uday will charge Commission
of 3% and also agrees to pay advance against receivables at an Interest Rate of 18% p.a. after withholding 10%
as Reserve. Should Jaidev accept Uday’s offer if the former’s ROI is 15%? Assume 360 days in a year.

Question 18 - Mtp April 2023

Sundaram limited a plastic manufacturing company had invested enormous amount of money in a new
expansion project. Due to such a great amount of capital investment, Company needs an additional ₹
2,00,00,000 in working capital immediately. The CFO has determined the following three feasible sources of
working capital funds:
Bank Loan: The company's bank will lend ₹2,30,00,000 at 12% per annum. However, the bank will require 15%
of the loan granted to be kept in a current account as the minimum average balance which otherwise would
have been just ₹ 50,000.
Trade Credit: A major supplier with 2/20 net 80 credit terms has approached for supply of raw material worth
₹1,90,00,000 p.m.
Factoring: factoring firm will buy the companies receivables of ₹ 2,50,00,000 per month, which have a
collection period of 60 days. factor will advance up to 75% of the face value of the receivables at 14 percent
per annum. Factor Commission will amount to 2% on all receivables purchased. Factoring will save credit
department expense and bad debts of ₹ 1,75,000 p.m. and
₹ 2,25,000 p.m.
Based on annual percentage cost, ADVISE which alternative should the company select. Assume 360 days a
year

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Management of Receivables
Choice of Credit Policy
Question 19 - Nov 99, Study Material
Radiance Garments Ltd. manufactures readymade garments and sells them on credit basis through a network
of dealers. Its present sale is ₹. 60 lakh per annum with 20 days credit period. The company is contemplating
an increase in the credit period with a view to increasing sales. Present variable costs are 70% of sales and the
total fixed costs ₹. 8 lakhs per annum. The company expects pre-tax return on investment @ 25%. Some other
details are given as under:
Proposed Credit Policy Average Collection period (days) Expected Annual Sales (₹. In Lakhs)
I 30 65
II 40 70
II 50 74
IV 60 75
Required: when credit policy should the company adopt? Present your answer in a tabular form. Assume 360
days a year. Calculation should be made upto two digits after decimal.

Credit Period Relaxation – Effect of Given After Tax Return Amount

Question 20 - May 08
The Sales Manager of AB Limited suggests that if credit period is given for 1.5 months then sales may likely to
increase by ₹. 1,20,000 per annum. Cost of sales amounted to 90% of sales. The risk of non-payment is 5%.
Income tax rate is 30%. The expected return on investment is ₹. 3375 (after tax.) Should the company accept
the suggestion of Sales Manager?

Question 21 - May 15
A new customer has approached a firm to establish new business connection. The customer require 1.5
month of credit. If the proposal is accepted, the sales of the firm will go up by ₹.2,40,000 per annum. The new
customer is being considered as a member of 10% risk of non-payment group.
The cost of sales amounts to 80% of sales. The tax rate is 30% and the desired rate of return is 40% (after tax).
Should the firm accept the offer? Give your opinion on the basis of calculations

Question 22 - Study Material

A trader whose current sales are in the region of ₹ 6 lakhs per annum and an average collection period of 30
days wants to pursue a more liberal policy to improve sales. A study made by a management consultant
reveals the following information:-
Credit Policy Increase in Collection Increase in Sales Present Default
Period anticipated
A 10 days ₹. 30,000 1.5%
B 20 days ₹. 48,000 2%
C 30 days ₹. 75,000 3%
D 45 days ₹. 90,000 4%
The selling price per unit is ₹ 3. Average cost per unit is ₹ 2.25 and variable costs per unit are ₹ 2. The current
bad debt loss is 1%. Required return on additional investment is 20%. Assume a 360 days year. ANALYSE
which of the above policies would you recommend for adoption?

Question 23 - Study Material

PQR Ltd. having an annual sales of ₹ 30 lakhs, is re-considering its present collection policy. At present, the
average collection period is 50 days and the bad debt losses are 5% of sales. The company is incurring an
expenditure of ₹ 30,000 on account of collection of receivables. Cost of funds is 10 percent.
The alternative policies are as under:
Particulars Alternative I Alternative II
Average Collection Period 40 days 30 days
Bad Debt Losses 4% of sales 3% of sales
Collection Expenses ₹. 60,000 ₹. 95,000
DETERMINE the alternatives on the basis of incremental approach and state which alternative is more
beneficial.

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Question 24 - May 09
Slow Payers are regular customers of Goods Dealers Ltd. and have approached the sellers for extension of
credit facility for enabling them to purchase goods. On an analysis of past performance and on the basis of
information supplied, the following pattern of payment schedule emerges in regard to Slow Payers:
Pattern of Payment Schedule
At the end of 30 days 15% of the bill
At the end of 60 days 34% of the bill
At the end of 90 days 30% of the bill
At the end of 100 days 20% of the bill
Non-Recovery 1% of the bill
Slow Payers want to enter into a firm commitment for purchase of goods of ₹ 15 lakhs in 20X7, deliveries to be
made in equal quantities on the first day of each quarter in the calendar year. The price per unit of commodity
is ₹ 150 on which a profit of ₹ 5 per unit is expected to be made. It is anticipated by Goods Dealers Ltd., that
taking up of this contract would mean an extra recurring expenditure of ₹ 5,000 per annum. If the opportunity
cost of funds in the hands of Goods Dealers is 24% per annum, would you as the finance manager of the seller
recommend the grant of credit to Slow Payers? ANALYSE. Workings should form part of your answer. Assume
year of 365 days.

Question 25 - Study Material

Mosaic Limited has current sales of ₹. 1.5 lakh per year. Cost of sales is 75 per cent of sales and bad debts are
one per cent of sales. Cost of sales comprises 80 per cent variable cost and 20 per cent fixed costs, while the
company’s required rate of return is 12 per cent. Mosaic Limited currently allows customers 30 days’ credit,
but is considering increasing this to 60 days’ credit in order to increase sales.
It has been estimated that this change in policy will increase sales by 15 per cent, while bad debts will increase
form one per cent to four per cent. It is not expected the policy change will result in an increase in fixed costs
and creditors and stock will be unchanged.
Should Mosaic Limited introduce the proposed policy?

Question 26 - Study Material

XYZ Corporation is considering relaxing its present credit policy and is in the process of evaluating two
proposed policies. Currently, the firm has annual credit sales of ₹. 50 lakhs and accounts receivable of ₹.
12,50,000. The current level of loss due to bad debts is ₹. 1,50,000. The firm is required to give a return of 20%
on the investment in new accounts receivables. The company’s variable costs are 70% of the selling price.
Given the following, which is the better option?
Particulars Present Policy Policy Option I Policy Option II
Annual credit sales 50,00,000 60,00,000 67,50,000
Accounts receivable 12,50,000 20,00,000 28,12,500
Bad debt losses 1,50,000 3,00,000 4,50,000

Question 27 - Nov 13, Nov 14

PTX Limited is considering a change in its present credit policy. Currently, it is evaluating two policies. The
company is required to give a return of 20% on the investment in new accounts receivables. The company’s
variable costs are 70% of the selling price.
Information regarding present and proposed policies are as follows:
Particulars Present policy Policy option 1 Policy option 2
Annual credit sales (₹.) 30,00,000 42,00,000 45,00,000
Debtors turnover ratio 4 times 3 times 2.4 times
Loss due to bad debts 3% of sales 5% of sales 6% of sales
Note: Return on investments in new accounts receivable is based on cost of investment in debtors. Which
option would you recommend?

Question 28 - Study Material

Easy Limited specializes in the manufacture of a computer component. The component is currently sold for ₹.
1,000 and its variable cost is ₹. 800. For the year ended 31-3-2010 the company sold on an average 400
components per month.
At present the company grants one month credit to its customers. The company is thinking of extending the
same to two months on account which the following is expected:
Increase in Sales 25%

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Increase in Stock ₹. 2,00,000

Increase in Creditors ₹. 1,00,000
You are required to advise the company on whether or not to extend the credit terms if:
(a) All customers avail the extended credit period of two months; and
(b) Existing customers do not avail the credit terms but only the new customers avail the same. Assume in
this case the entire increase in sales is attributable to the new customers. The company expects a minimum
return of 40% on investment

Credit Period Relaxation Decision – Effect of Tax Rate and Given After Tax Return
Question 29 - Nov 03
A firm has a current sales of ₹. 2,56,48,750. The firm has unutilized capacity. In order to boost its sales, it
sales, it is considering the relaxation in its credit policy. The proposed terms of credit will be 60 days credit
against the present policy of 45 days. As a result, the bad debts will increase from 1.5% to 2% of sales. The
firm’s sales are expected to increase by 10%. The variable costs are 72% of the sales. The firm’s corporate tax
rate is 35%, and it requires and after tax return of 15% on its investment. Should the firm change its credit
period?

Credit Relaxation Decision – Effect of Discount Offer – Weighted Average Collection Period
Question 30 -
New Ltd sells on credit terms “2/15 net 45”. Its present Sales are ₹. 100 Lakhs per annum, Fixed Costs are ₹.
12 Lakhs per annum and Variable Costs are 70% of Sales. The Company’s cost of funds is 24% and it is
observed that 40% of the customers avail the discount, while the rest pay on the due date.
The Company is considering relaxing its credit terms to “3/18 net 45’. This relaxation is expected to increase
Sales by 25% and Fixed Costs by ₹. 3 Lakhs per annum. Due to economy of operations, Variable Costs will be
reduced to 68% on all Sales. It is expected that 80% of the customers will avail the discount, the rest paying on
the due date.
Advise whether the relaxation in credit terms is worthwhile.

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Treasury and Cash Management

Cash Budget
Question 31 - Study Material
Prepare monthly cash budget for six months beginning from April 2010 on the basis of the following
information:
(i) Estimated monthly sales are as follows:
Particulars Amount(₹) Particulars Amount(₹)
January 1,00,000 June 80,000
February 1,20,000 July 1,00,000
March 1,40,000 August 80,000
April 80,000 September 60,000
May 60,000 October 1,00,000

(ii) Wages and salaries are estimated to be payable as follows:

Particulars Amount (₹) Particulars Amount (₹)
April 9,000 July 10,000
May 8,000 August 9,000
June 10,000 September 9,000
(iii) Of the sales, 80% is on credit and 20% for cash. 75% of the credit sales are collected within one month
and the balance in two months. There are no bad debt losses.
(iv) Purchase amount to 80% of sales and are made and paid for in the month preceding the sales.
(v) The firm has 10% debentures of ₹ 1,20,000. Interest on these has to be paid quarterly in January, April
and so on.
(vi) The firm is to make an advance payment of tax of ₹ 5,000 in July, 2010.
(vii) The firm had a cash balance of ₹ 20,000 on April 1, 2010, which is the minimum desired level of cash
balance. Any cash surplus/deficit above or below this level is made up by temporary investments /liquidation
of temporary investment or temporary borrowings at the end of each month (interest on these to be ignored).

Question 32 - Mtp Mar 2021

Prepare monthly cash budget for the first six months of 2021 on the basis of the following information:
(i) Actual and estimated monthly sales are as follows:
Actual (₹.) Estimated (₹.)
October 2020 2,00,000January 2021 60,000
November 2020 2,20,000February 2021 80,000
December 2020 2,40,000March 2021 1,00,000
April 2021 1,20,000
May 2021 80,000
June 2021 60,000
July 2021 1,20,000
(ii) Operating Expenses (including salary & wages) are estimated to be payable as follows:
Month (₹.) Month (₹.)
January 2021 22,000April 2021 30,000
February 2021 25,000May 2021 25,000
March 2021 30,000June 2021 24,000
(iii)Of the sales, 75% is on credit and 25% for cash. 60% of the credit sales are collected after one month, 30%
after two months and 10% after three months.
(iv)Purchases amount to 80% of sales and are made on credit and paid for in the month preceding the sales.
(v) The firm has 12% debentures of ₹.1,00,000. Interest on these has to be paid quarterly in January, April and
so on.
(vi)The firm is to make an advance payment of tax of ₹. 5,000 in April.
(vii)The firm had a cash balance of ₹. 40,000 at 31st Dec. 2020, which is the minimum desired level of cash
balance. Any cash surplus/deficit above/below this level is made up by temporary investments/liquidation of
temporary investments or temporary borrowings at the end of each month (interest on these to be ignored).

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Question 33 - Study Material

From the following information relating to a departmental store, you are required to prepare for the three
months ending 31st March, 2010:
(a) Month wise cash budget on receipts and payments basis; and
(b) Statement of Sources and use of funds for the three months period.
It is anticipated that the working capital at 1st January, 2010 will be as follows:
Particulars ₹ '000's
Cash in hand and at bank 545
Short term investments 300
Debtors 2,570
Stock 1,300
Trade Creditors 2,110
Other creditors 200
Dividends payable 485
Tax due 320

Budgeted Profit Statement (₹ In '000's)

Particulars January February March
Sales 2,100 1,800 1,700
Cost of sales 1,635 1,405 1,330
Gross Profit 465 395 370
Administrative Selling and Distribution
Expenses 315 270 255
Net Profit before tax 150 125 115

Budgeted balances at the end of each months (₹ In '000's)

Particulars 31st Jan. 29th Feb. 31st March
Short term investments 700 - 200
Debtors 2,600 2,500 2,350
Stock 1,200 1,100 1,000
Trade Creditors 2,000 1,950 1,900
Other creditors 200 200 200
Dividend Payable 485 - -
Tax due 320 320 320
Plant (depreciation ignored) 800 1,600 1,550
Depreciation amount to ₹ 60,000 is included in the budgeted expenditure for each month.
Capital Expenditure amounting to ₹ 8,00,000 is expected to be incurred during February 2010 and proceeds
from sale of Plant and Equipment of ₹ 50,000 is expected in March 2010.

Solution 33:
Cash Budget
(a) 3 month ending 31st March, 2010 (₹ In 000's)
Particulars January 2010 February 2010 March 2010
Opening cash balances 545 315 65
Add: Receipts
From Debtors 2,070 1,900 1,850
Sale of Investments - 700 -
Sale of plant - - 50
Total (A) 2615 2,915 1,965
Payments:
Creditors 1,645 1,355 1,280
Expenses 255 210 195
Capital Expenditure - 800 -
Payment of dividend - 485 -
Purchase of investments 400 - 200
Total Payments (B) 2,300 2,850 1,675
Closing Cash Balance (A) – (B) 315 65 290

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 Chapter 7 - Working Capital Management

Working Notes:
(1) Payment to Creditors (₹ In 000’s)
Particulars January 2010 February 2010 March 2010
Cost of Sales 1,635 1,405 1,330
Add: Closing Stock 1,200 1,100 1,000
2,835 2,505 2,330
Less: Opening Stock (1,300) (1,200) (1,100)
Purchases 1,535 1,305 1,230
Add: Opening Creditors 2,110 2,000 1,950
3,645 3,305 3,180
Less: Closing Creditors (2,000) (1,950) (1,900)
Payment 1,645 1,355 1,280

(2) Receipts from Debtors (₹ In 000’s)

Particulars January 2010 February 2010 March 2010
Opening Debtors 2,570 2,600 2,500
Add: Sales 2,100 1,800 1,700
4,670 4,400 4,200
Less: Closing Debtors (2,600) (2,500) (2,350)
Receipt 2,070 1,900 1,850

(b) Statement of Sources and uses of Funds for the Three Month Period
Ending 31st March, 2010
Amount (₹ In
Particulars 000’s)
Sources:
Funds from operation:
Net Profit 390
Add: Depreciation 180 570
Sale of Plant 50
620
Decrease in Working Capital 665
Total 1,285
Uses:
Purchase of Plant 800
Payment by dividends 485
Total 1,285

Statement of Changes in Working Capital (₹ In 000’s)

January March
Particulars 2010 2010 Increase Decrease
Current Assets:
Cash in hand and at Bank 545 290 255
Short term Investment 300 200 100
Debtors 2,570 2,350 220
Stock 1,300 1,000 300
Total Current Assets (A) 4,715 3,840
Current Liabilities:
Trade Creditors 2,110 1,900 210 -
Other Creditors 200 200 - -
Tax Due 320 320 - -
Total Current Liabilities (B) 2,630 2,420
Working Capital (A) – (B) 2,085 1,420
Decrease in Working Capital 665 665
2,085 2,085 875 875

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Question 34 - Study Material

The selling price of a book is ₹ 15, and sales are made on credit through a book club and invoiced on the last
day of the month. Variable costs of production per book are materials (₹ 5), labour (₹ 4), and overhead (₹ 2).
The sales manager has forecasted the following volumes:
Nov Dec Jan Feb March April May June July Aug
No. of
Books 1,000 1,000 1,000 1,250 1,500 2,000 1,900 2,200 2,200 2,300

Customers are expected to pay as follows:

One month after the sale 40%
Two months after the sale 60%
The company produces the books two months before they are sold and the creditors for materials are paid
two months after production.
Variable overheads are paid in the month following production and are expected to increase by 25% in April;
75% of wages are paid in the month of production and 25% in the following month. A wage increase of 12.5%
will take place on 1st March.
The company is going through a restructuring and will sell one of its freehold properties in May for ₹ 25,000,
but it is also planning to buy a new printing press in May for ₹ 10,000. Depreciation is currently ₹ 1,000 per
month, and will rise to ₹ 1500 after the purchase of the new machine.
The company’s corporation tax (of ₹ 10,000) is due for payment in March.
The company presently has a cash balance at bank on 31 December 2010, of ₹ 1500.
You are required to prepare a cash budget for the six months from January to June.

Question 35 - Study Material

From the information and the assumption that the cash balance in hand on 1st January 2010 is ₹ 72,500
prepare a cash budget. Assume that 50 per cent of total sales are cash sales. Assets are to be acquired in the
months of February and April. Therefore, provisions should be made for the payment of ₹ 8,000 and ₹ 25,000
for the same. An application has been made to the bank for the grant of a loan of ₹ 30,000 and it is hoped that
loan amount will be received in the month of May.
It is anticipated that a dividend of ₹ 35,000 will be paid in June. Debtors are allowed one month’s credit.
Creditors for materials purchased and overheads grant one month’s credit. Sales commission at 3 per cent on
sales is paid to the salesman each month.
Material Salaries & Production Office & Selling
Months Sales (₹) Purchases (₹) Wages (₹) Overheads (₹) Overheads (₹)
January 72,000 25,000 10,000 6,000 5,500
February 97,000 31,000 12,100 6,300 6,700
March 86,000 25,500 10,600 6,000 7,500
April 88,600 30,600 25,000 6,500 8,900
May 1,02,500 37,000 22,000 8,000 11,000
June 1,08,700 38,800 23,000 8,200 11,500

Cash Budget for Manufacturing Concern

Question 36 - May 10
The following details are forecasted by a Company for the purpose of effective utilization and management of
Cash:
· Estimated Sales and Manufacturing Costs:
Year 2010 Month Sales (₹) Materials (₹) Wages (₹) Overheads (₹)
April 4,20,000 2,00,000 1,60,000 45,000
May 4,50,000 2,10,000 1,60,000 40,000
June 5,00,000 2,60,000 1,65,000 38,000
July 4,90,000 2,82,000 1,65,000 37,500
August 5,40,000 2,80,000 1,65,000 60,800
September 6,10,000 3,10,000 1,70,000 52,000
● Credit-Terms:
(a) 20% Sales are on Cash. 50% of the Credit Sales are collected next month and the balance in the
following month.
(b) Credit allowed by Suppliers is 2 months.
(c) Delay in payment of Wages is ½ (one-half) month and of Overheads is 1 (one) month.

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 Chapter 7 - Working Capital Management

● Interest on 12% Debentures of ₹ 5,00,000 is to be paid half-yearly in June and December.

● Dividends on Investments amounting to ₹ 25,000 are expected to be received in June.
● A New Machinery will be installed in June at a cost of ₹ 4,00,000 payable in 20 monthly instalments
from July onwards.
● Advance Income-Tax to be paid in August is ₹ 15,000.
● Cash balance on 1st June is expected to be ₹ 45,000 and the Company wants to keep it at the end of
every month around this figure, the excess cash (in multiple of thousands rupees) being put in Fixed
Deposit.
You are required to prepare monthly Cash Budget on the basis of above information for four months beginning
from June.

Solution 36:
Cash Budget for the months of June, July, August and September
Particulars June (₹) July (₹) August (₹) September (₹)
Opening Balance 45,000 45,500 45,500 45,000
Add: Receipts
Cash Sales (20% of respective month's Sales) 1,00,000 98,000 1,08,000 1,22,000
Collection from Debtors 3,48,000 3,80,000 3,96,000 4,12,000
Interest on Investments 25,000 - - -
Total Receipts (A) 5,18,000 5,23,500 5,49,500 5,79,000
Payments:
Creditors (2 months) April paid in June, and so on. 2,00,000 2,10,000 2,60,000 2,82,000
Wages (½ of previous month + ½ of Current month) 1,62,500 1,65,000 1,65,000 1,67,500
Overheads (1 month), previous month expenses paid
now 40,000 38,000 37,500 60,800
Interest on Debentures (6% on ₹ 5,00,000) 30,000 - - -
Instalment on Machinery (₹ 4,00,000 ÷ 20 months) - 20,000 20,000 20,000
Advance Tax - - 15,000 -
Total Payments (B) 4,32,500 4,33,000 4,97,500 5,30,300
Closing Balance before investment in FD (A) – (B) 85,500 90,500 52,000 48,700
Investment in Fixed Deposit (multiples of 1,000)
(Balancing Figure) 40,000 45,000 7,000 3,000
Closing Balance (required around ₹ 45,000) 45,500 45,500 45,000 45,700
Working Notes:
Computation of Collection from Debtors
Particulars April (₹) May (₹) June (₹) July (₹) August (₹) September (₹)
Total Sales 4,20,000 4,50,000 5,00,000 4,90,000 5,40,000 6,10,000
Cash Sales 84,000 90,000 1,00,000 98,000 1,08,000 1,22,000
Credit Sales 3,36,000 3,60,000 4,00,000 3,92,000 4,32,000 4,88,000
Receipt:
50% 1,68,000 1,80,000 2,00,000 1,96,000 2,16,000
50% 1,68,000 1,80,000 2,00,000 1,96,000
Total Receipts 3,48,000 3,80,000 3,96,000 4,12,000

Cash Management Models

Question 37 -
Briefly explain William J. Baumal’s EOQ model for optimum cash balance?
Solution 37 -
The Baumol model is as follows:
1. Assumptions:
The Optimum Cash Balance model is based on the following assumptions:
(a) Uniform Cash Flows: Cash payments arise uniformly during a year.
(b) Fixed Transaction Costs: Surplus cash can be invested in short-term marketable securities. However, for
every purchase of securities (i.e. investments) and for every sale (i.e. disposal of investments), fixed
transaction costs are incurred, e.g. Brokerage, registration costs, etc.
(c) Fixed Holding Costs: Surplus cash, if held by the Firm, entails loss of interest at a fixed rate. This
constitutes the carrying costs of cash, i.e. the interest foregone on marketable securities.

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 Chapter 7 - Working Capital Management

(d) Free Marketability: Short-term instruments can be freely traded. The Firm can invest them at any time, and
sell off/dispose investments at any time.

2. Principle:
According to Baumol Model, Optimum Investment Size is that level of investment where the total of
Transaction Costs per annum and Carrying Costs per annum are the minimum.

3. Formula: Optimum Transfer Size of Cash =

Where
A = Annual (Monthly) Cash Requirement.
T = Fixed Cost per transaction
C = Opportunity cost of one rupee per annum (or Per Month)

4. (a)Average Cash Balance = ½ of Optimum Transfer Size

(b)Associated Costs of Optimum Investment Size = Transaction Costs p.a. + Interest Costs p.a. = [(No. of
Transaction X Cost per
Transaction) + (Average Cash balance × Interest Rate p.a.)]
(c) At the Optimum Investment Size level, Transaction Costs p.a. = Interest Costs p.a. = ½ of Associated Costs
per annum

Question 38 -
Explain Miller – Orr Cash Management Model?
Solution 38 -
1. Stochastic Cash Flow Assumption:
(a) Under this model, cash payments are presumed at different amounts on different days, i.e. variable or
stochastic, e.g. Wage and Salary payment arises in the first week etc.
(b) With this assumption, this model is designed to determine the time and size of transfers between an
Investment Account and Cash Account.

2. Theory: This model Operates as under:

(a) Upper and lower limits can be fixed for cash balances, as outflows do not exceed a certain limit on any day.
These limits are determined based on fixed transaction costs, interest foregone on marketable securities and
the degree of likely fluctuations in cash balances.
(b)During the period when Cash Balance stays between high and low limits, there are no transactions between
cash and marketable securities.
(c) When cash balance reaches the upper limit, surplus cash is invested in marketable securities, to bring
down the cash balance to the average limit or return point.
(d) Cash Outflows/Payments are not uniform during the year.
(e) When cash balance touches the lower limit, investments (marketable securities) are disposed off so that
cash balances goes up to the average limit or return point.

Optimal Investment Size – Baumol Model

Question 39 - Rtp, May 14
Decision Ltd. estimates its Total Cash Requirement at ₹ 4 Lakhs next year. Its Opportunity Cost of Funds is
15% per annum. The Company will incur ₹ 300 per transaction to convert its short-term securities to cash and
vice-versa. Determine the Optimum Cash Balance according to Baumol Model.

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 Chapter 7 - Working Capital Management

Solution 39 -
2𝐴𝑇
Optimum Transfer Size = 𝐶
2×4,00,000×300
= 0.15
= ₹ 40,000

Question 40 - Study Material, May 00

JPL has two dates when it receives its cash inflows, i.e., Feb. 15. On each of these dates, it expects to receive
₹ 15 crore. Cash expenditure is expected to be steady throughout the subsequent 6 months period. Presently,
the ROI in marketable securities is 8% per annum, and the cost of transfer from securities to cash is ₹ 125
each times at a transfer occurs.
(i) What is the optimal transfer size using the EOQ model? What is the average cash balance?
(ii) What would be your answer to part (i), if the ROI were 12% per annum and the transfer costs were ₹ 75?
Why do they differ from those in part (i)?
Solution 40 -
2𝐴𝑇
(i) Optimum Transfer Size of Cash = 𝐶
2×30,00,00,000×125
= 0.08
= ₹ 9,68,245
Average Cash Balance = ½ × Optimum Transfer Size of Cash
= ½ × ₹ 9,68,245 = ₹ 4,84,123

2𝐴𝑇
(ii) Optimum Transfer Size of Cash = 𝐶
2×30,00,00,000×75
= 0.12
= ₹ 6,12,372
Average Cash Balance = ½ × Optimum Transfer Size of Cash
= ½ × ₹ 6,12,372 = ₹ 3,06,186

Reasons for difference between Present and Revised: (a) Increase in Opportunity Cost of holding cash, i.e. 8%
to 12%, (b) Decrease in transaction/ transfer costs.

Lock Box System

Question 41 - Rtp
ABC Limited currently has a centralized billing system. It takes around 4 days for customers mailed payments
to reach the central billing location. Subsequently, it takes another 1 ½ days for processing these payments,
only after which deposits are made. ABC Limited has a daily average collection of ₹ 5,00,000. The company
plans to initiate a lock box system in which customers mailed payments would reach the receipt location 2 ½
days earlier. Further the process time would be reduced by another 1 day, since each lock box bank would
collect mailed deposits twice daily.
You are required to:
(i) Determine the reduction in cash balances that can be achieved through the use of a lock box system.
(ii) Determine the reduction in opportunity cost of the present system by introduction of Lock box system
assuming a 5% return on short-term investments.
(iii)If the annual cost of the lock box system is ₹ 80,000, should the system be initiated?
Solution 41:
(i)Total time saving = 3 & ½ days
Time savings × Daily average collection = Reduction in cash balances achieved
3 & ½ days × ₹ 5,00,000 = ₹ 17,50,000
(ii) 5% × ₹ 17,50,000 = ₹ 87,500
(iii) Since the opportunity cost of the present system (₹ 87,500) exceeds the cost of the lock box system (₹
80,000), the system should be initiated.

Question 42 - Nov 2022

K Ltd. has a Quarterly cash outflow of ₹ 9,00,000 arising uniformly during the Quarter. The company has an
Investment portfolio of Marketable Securities. It plans to meet the demands for cash by periodically selling
marketable securities. The marketable securities are generating a return of 12% p.a. Transaction cost of
converting investments to cash is
₹ 60. The company uses Baumol model to find out the optimal transaction size for converting marketable
securities into cash.

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Consider 360 days in a year.

You are required to Calculate
1. Company's average cash balance,
2. Number of conversions each year and
3. Time interval between two conversions.

Inventory Management
Computation of EOQ
Question 43 - NOV 97
The following details are available in respect of a firm:
● Annual requirement of inventory 40,000 units
● Cost per unit (other than carrying and ordering cost) ₹ 16
● Carrying cost are likely to be 15% per year
● Cost of placing order ₹ 480 per order
Determine the economic ordering quantity.

Solution 43 -
Carrying cost per annum = Cost per unit × Carrying cost % p.a.
= ₹ 16 × 0.15 = ₹ 2.40
2 × 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑝.𝑎. × 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑜𝑟𝑑𝑒𝑟
EOQ = 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
2 × 40,000 × 480
= 2.40
= 4,000 units

Question 44 - NOV 07
The demand for a certain product is random. It has been estimated that the monthly demand of the product
has a normal distribution with a mean of 390 units. The unit price of product is ₹ 25. Ordering cost is ₹ 40 per
order and inventory carrying cost is estimated to be 35 per cent per year. Calculate Economic Order Quantity
(EOQ).

Solution 44 -
A = 390 units × 12 = 4,680 units
O = ₹ 40
C = 35% × ₹ 25 = ₹ 8.75
2×𝐴×𝑂
EOQ = 𝐶
2 × 4,680 × 40
= 8.75
= 206.85 units

EOQ and Discount

Question 45 - Nov 08
A publishing house purchases 72,000 rims of a special type paper per annum at cost ₹ 90 per rim. Ordering
cost per order is ₹ 500 and the carrying cost is 5 per cent per year of the inventory cost. Normal lead time is 20
days and safety stock is Nil. Assume 300 working days in a year:
You are required to:
(i) Calculate the Economic Order Quantity (E.O.Q).
(ii) Calculate the Reorder Inventory Level.
(iii) If a 1 per cent quantity discount is offered by the supplier for purchases in lots of 18,000 rims or
more, should the publishing house accept the proposals?

Solution 45 -
2𝐴𝑂
(i) EOQ = 𝐶
Where,
A = Annual consumption
O = Ordering cost per order
C = Stock carrying cost per unit annum

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 Chapter 7 - Working Capital Management

2 × 72,000 × 500
EOQ = 5% 𝑜𝑓 𝑅𝑠. 90
= 1, 60, 00, 000 = 4,000 Rims.

(ii) Re-order Level = Normal Lead Time × Normal Usage

= 20 × 240 = 4,800 Rims.
Working Notes:
𝐴𝑛𝑛𝑢𝑎𝑙 𝑈𝑠𝑎𝑔𝑒
Normal Usage = 𝑁𝑜𝑟𝑚𝑎𝑙 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
72,000
= 300
= 240 Rims.

(iii) Evaluation of quantity Discount Offer

Particulars EOQ Discount Offer
Size of order 4,000 Rims 18,000 Rims
No. of orders in year 18 4
Average Inventory (Order size/2) 2,000 Rims 9,000 Rims
Cost: ₹ ₹
Ordering Cost @ ₹ 500 per order 9,000 2,000
Inventory carrying cost
At EOQ: (4,000/2) × ₹ 4.5 9,000 -
At Discount offer: (18,000/2) × ₹ 4.455 - 40,095
Purchase Cost
At EOQ: 72,000 × ₹ 90 64,80,000 -
At discount offer: 72,000 × ₹ 89.10 - 64,15,200
Total Cost 64,98,000 64,57,295
The total cost is less in case of quantity discount offer. Hence, quantity discount offer should be accepted.

Evaluation of Alternative Working Capital Policies

Question 46 - Study Material, Nov 01
A company is considering its working capital investment and financial policies for the next year. Estimated
fixed assets and current liabilities for the next year are ₹ 2.60 crores and ₹ 2.34 crores respectively. Estimated
Sales and EBIT depend on current assets investment, particularly inventories and book-debts. The financial
controller of the company is examining the following alternative Working CapitalPolicies:
(₹ In Crores)
Working Capital Policy Investment in Current Assets Estimated Sales EBIT
Conservative 4.50 12.30 1.23
Moderate 3.90 11.50 1.15
Aggressive 2.60 10.00 1.00
After evaluating the working capital policy, the Financial Controller has advised the adoption of the moderate
working capital policy. The company is now examining the use of long-term and short-term borrowings for
financing its assets. The company will use ₹ 2.50 crores of the equity funds. The corporate tax rate is 35%. The
company is considering the following debt alternatives:
Financing Policy Short-term Debt Long-term Debt
Conservative 0.54 1.12
Moderate 1.00 0.66
Aggressive 1.50 0.16
Interest Rate – Average 12% 16%
You are required to calculate the following:
(1) Working Capital Investment for each policy:
(a) Net Working Capital position; (b) Rate of Return; (c) Current ratio.
(2) Financing for each policy;
(a) Net Working Capital; (b) Rate of Return of Shareholders equity; (c) Current ratio.

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 Chapter 7 - Working Capital Management

Management of Payables
Question 47.
How is the cost of Payables Computed?
Solution 47:
The following equation can be used to calculate nominal cost, on an annual basis of not taking the discount:
𝑑 365 𝑑𝑎𝑦𝑠
100 − 𝑑
× 𝑡
The cost of lost cash discount can be estimated by the formula:
365
100 𝑡

100−𝑑
–1
Where,
d = Size of discount i.e. for 6% discount, d = 6
t = The reduction in the payment period in days, necessary to obtain the early discount or Days Credit
Outstanding – Discount Period.

Practical Problems
Question 48 - Study Material
Suppose ABC Ltd. has been offered credit terms from its major supplier of 2/10, net 45. Hence the company
has the choice of paying ₹ 98 per ₹ 100 or to invest the ₹ 98 for an additional 35 days and eventually pay the
supplier ₹ 100 per ₹ 100. The decision as to whether the discount should be accepted depends on the
opportunity cost of investing ₹ 98 for 35 days. What should the company do?

Question 49 -
XYZ Limited normally pays its Suppliers in the third month after invoicing. It is now offered a 2% discount for
payment within one month on invoicing. Payments are at ₹ 3,00,000 per month, and the Company operates on
Bank Overdraft on which interest is charged at 14.5%. Advise whether the offer should be accepted.
Would your answer differ if the Company were given 3% discount, all other conditions remaining the same as
above?
Solution 49 -
(a) When Discount = 2%
Particulars Amount (₹)
Benefit = Discount Received [₹ 3,00,000 × 2%] 6,000
2
Cost = Opportunity Cost of funds due to early payment [₹ 3,00,000 × 14.5% × 12 ] 7,250
(Payment being made two months in advance, i.e. 3rd month Vs 1st month)
Net Benefit/ (Cost) per month (1,250)
Net Payment to Supplier will be ₹ 3,00,000 less 2% discount = ₹ 2,94,000.
Interest can also be calculated on ₹ 2,94,000, being the actual outflow of cash.
2
So, Interest Cost = ₹ 2,94,000 × 14.5% × 12 = ₹ 7,105
Conclusion: As there is a Net Cost of ₹ 1,250, the discount offer is not worthwhile. The Company may pay the
Supplier in the third month after invoicing.

(b) When Discount = 3%, Benefit = Discount Received = ₹ 3,00,000 × 3% = ₹ 9,000.

Net Benefit = ₹ 9,000 – ₹ 7,250 = ₹ 1,750.
Conclusion: Since there is a Net Benefit, the 3% Discount Offer may be accepted and the payment can be made
early.

Question 50 - Study Material

The Dolce Company purchases raw materials on terms of 2/10, net 30 . A review of the company’s record by
the owner , Mr. Gautam , revealed that payments are usually made 15 days after purchases are made. When
asked why the firm did not take the advantage of its discounts , the accountant , Mr. Rohit , replied that it cost
only 2 per cent for these funds , whereas a bank loan would cost the company 12 per cent .
(a) Analyse what mistake is Rohit making ?
(b) If the firm could not borrow from the bank and was forced to resort to the use of trade credit funds , what
suggestions might be made to Rohit that would reduce the annual interest cost ? IDENTIFY.

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