Analysis of potential arrangement with supplier, Financial Accounting

Assignment Help:

At current the working capital cycle is

Receivables days $0.4m/$10m * 365 = 15 days

Inventory days $0.7m/$8m * 365 = 32 days (cost of sales = $10m - $2m)

Payables days $1.5m/$8m * 365 = (68 days)

Total (21 days)

Clearly Keswick is exceptionally resourceful in its use of working capital.

The planned arrangement would shorten payables days in relation to half of cost of sales to 15 days. The effect is to inferior the average to

(½ * 68 days) + (½ * 15 days) = 41.5 days

Overall this will rise cycle time to

[15 + 32 - 41.5 days] that is to 5.5 days

Interest cover

At present interest cover earnings prior to interest and tax divided by interest is $2m/$0.5m

= 4.0 times this appears safe.

The advanced payment will increase interest costs but will generate savings via the discount. The discount relate to half of cost of sales that is ½ × $8m × 5% = $0.2m. The EBIT will rise accordingly.

The net advanced payment of ($4m - $0.2m) = $3.8m will have to be financed for an extra (68 - 15) days generating interest costs of

[$3.8m × 12% × 53/365] = $66,214

The interest covers somewhat declines to

[$2.0m + $0.2m]/[$0.50m + $0.066m] = 3.89 times

Profit after tax, ROE and EPS

The "before" and "after" income statements seems thus

1036_Analysis of potential arrangement with supplier.png

The proposal seems beneficial to Keswick in terms of the effect on profitability measures that is EPS, EBIT, PAT, and ROE. But it does have a slightly harmful effect on its interest cover. It as well lengthens its working capital cycle and turns it into a net demander of working capital. This suggests an raise in its capital gearing.

Prior to the adjustment gearing at book values (overdraft/shareholder's funds) was

$3.0m/$2m = 150%

The overdraft will raise by

($3.8m × 53/365] = $0.55m

Ignoring the helpful effect on equity, gearing after the adjustment becomes

$3.55m/$2m = 178%

This appears rather dangerous considering the short-term nature of much of the debt and Keswick's low liquidity. May be Keswick must reconsider its policy regarding long-term borrowing although whether prospective lenders would oblige is probably doubtful.


Related Discussions:- Analysis of potential arrangement with supplier

What you understand by the term gender budgeting, Question 1: (a) "MT...

Question 1: (a) "MTEF is about resource control, resource allocation and resource utilization." You are required to identify and discuss the different stages of MTEF. (N

Equitable apportionments-executorship laws and accounts, Equitable apportio...

Equitable apportionments There are five leading cases where the courts have laid down rules to meet specific situations in which there is a conflict of interest between life tena

Holding company with more than one subsidiary company, Holding company with...

Holding company with more than one subsidiary company Under this type of structure, the holding company controls more than one company. For example H ltd may Own 80% of S1, 75%

Amalgamation of partnership, Please I need assistance with steps to prepare...

Please I need assistance with steps to prepare amalgamation

Variation of securities-executorship laws and accounts, Variation of securi...

Variation of securities It would seem logical to carry out a strict apportionment between income and capital every time investments are bought or sold. If this were done, it wo

Sales volume reaches the maximum capacity, Sales volume reaches the maximum...

Sales volume reaches the maximum capacity of the new machine in Year 4. The positive NPV point to that the investment in Machine Two is financially acceptable althoug

Successive interest computations, Show that if an investment of P dollars d...

Show that if an investment of P dollars declines by 4% during a year , the balance at the end of the year is P(1-.04) that is P(.96) ?

What do you mean by operating agreement, Q. What do you mean by Operating A...

Q. What do you mean by Operating Agreement? Operating Agreement - Agreement, generally a written document which sets out the rules by which a LIMITED LIABILITY COMPANY (LLC) is

Financial statements, Describe the following questions:- Q.1 Explain how...

Describe the following questions:- Q.1 Explain how financial statements assist in the capital allocation process. How are financial statements limited? Which financial statement

Determine the present value - annuity, Assume you are receiving an amount ...

Assume you are receiving an amount of Rs.5000 twice in a year for subsequent five years one time at the starting of the year and another amount of Rs. 5000 at the ending of the yea

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd