Question
The table below shows three efficiency ratios for a company for the year ended 2023, along with the industry averages for the same period: & 2023 & }(l) Industry Average Average settlement period for trade payables & 25 days & 15 days Average settlement period for trade receivables & 41 days & 35 days Average inventory turnover period & 30 days & 20 days Required: (a) Evaluate the efficiency of the company in managing its working capital by analysing the three ratios provided. Ensure that your discussion covers what each ratio represents and the potential reasons behind the observed differences between the company's ratios and the industry averages. ( 9 marks) (b) Based on your evaluation above, discuss two potential implications of having a prolonged period for trade payables. (5 marks) (c) Based on your evaluation, recommend two specific actions/strategies that the manager can take to optimisme the company's settlement period for trade payables. You must explain how implementing these recommendations could lead to improved efficiency and potentially align the company's ratios more closely with industry averages. (6 marks)
Answer
4.7
(341 Votes)
Michael
Elite · Tutor for 8 years
Answer
(a) 1. The company is less efficient in terms of obligations settlement within the purchase department as evident by 10 more days taken than industry average. This delay might occur when engaging extended finance payback agreements with suppliers or an attempt to maintain their liquid asset.2. From the point of view of receivables management within the sales wing, the company again lags 6 days behind from the industry average, stating lesser effectiveness. Here, a lenient or disadvantageous credit policy or weaknesses in recovery mechanisms may contribute to this state of affairs.3. The company retains items too long within the inventory wing. Escalating inventory cost or inefficient management might unfold drastic loss from asset fixation.(b) Lingering trade payable periods can 1) deteriorate supplier relationships leading to inconvenience and, 2) prompt borrowing funds to meet short stamina financial outlay affecting financial health.(c) Managing trade payables might include: 1) leveraging an attractive credit facility comparing trend & costs, strategic sourcing,, and harmonized procurement; 2) engaging dynamic discount management offers swift payment to suppliers in a forbearing cash position. In pro, both practices tender financial optimization plus strengthen buying relationships.
Explanation
## Step 1:The first ratio we are analyzing is the average settlement period for trade payables, expressed in days. This criterion reveals how long it takes, on average, for a company to pay off its trade liabilities. It is computed by dividing the ending accounts payable by the average daily purchases.Considering this ratio, the company is less efficient than the industry in managing its liabilities. This can be portrayed by the firm's higher ratio of 25 days than the industry average of 15 days. Possible explanations for this could be that the company leverages longer payment terms with its suppliers or perhaps struggles with cash inflows to meet its current obligations.## Step 2:The second ratio is average settlement period for trade receivables also obtained in days. This ratio specifies the period it takes on average for a company to receive the cash from trade debt, signifying how well a firm is managing its accounts receivables. The lower the period, the quicker the collection and hence superior working capital management. With regard to the standard settlement period for trade receivables, the company takes longer (41 days) to receive payment from its debtors than the industry average (35 days). This implies the company has lower efficiency handling accounts receivable. The likely reasons are that the company allows customers lengthy credit terms or has weak collection execution.## Step 3:The final ratio of concern, the average inventory turnover period (denoted in days), figures the interval a firm maintains its inventory. An optimal period ensures firms enjoy efficient management of inventory. This company, on the basis of inventory turnover period, retains its inventory for too long: by a full 10 days longer than the industry, i.e., 30 vs 20 days. This suggests the company's capital is tied up in inventory and poor inventory management techniques add to this challenge.