Calculation of Net Working Capital (NWC)
Net Working Capital Formula: \[ \text{NWC} = \text{Current Assets} - \text{Current Liabilities} \]
Current Year (2024)
Current Assets:
- Cash: R25,000
- Accounts Receivable: R60,000
- Inventory: R80,000
Total Current Assets: \[ \text{Total Current Assets} = 25,000 + 60,000 + 80,000 = R165,000 \]
Current Liabilities:
- Accounts Payable: R50,000
- Short-Term Loans: R20,000
Total Current Liabilities: \[ \text{Total Current Liabilities} = 50,000 + 20,000 = R70,000 \]
NWC for Current Year (2024): \[ \text{NWC} = 165,000 - 70,000 = R95,000 \]
Next Fiscal Year (2025)
Current Assets:
- Cash: R30,000
- Accounts Receivable: R70,000
- Inventory: R90,000
Total Current Assets: \[ \text{Total Current Assets} = 30,000 + 70,000 + 90,000 = R190,000 \]
Current Liabilities:
- Accounts Payable: R55,000
- Short-Term Loans: R25,000
Total Current Liabilities: \[ \text{Total Current Liabilities} = 55,000 + 25,000 = R80,000 \]
NWC for Next Fiscal Year (2025): \[ \text{NWC} = 190,000 - 80,000 = R110,000 \]
Summary of NWC Calculations:
- Current Year (2024) NWC: R95,000
- Next Fiscal Year (2025) NWC: R110,000
Change in Net Working Capital
Change in NWC: \[ \text{Change in NWC} = \text{NWC}{2025} - \text{NWC}{2024} = 110,000 - 95,000 = R15,000 \]
Factors Contributing to Change:
- Increase in Current Assets: The increase in accounts receivable and inventory has positively impacted the NWC.
- Increase in Accounts Payable: The increase allows the company to maintain a higher degree of liquidity while meeting obligations.
- Increase in Short-Term Loans: This can provide additional working capital but needs to be considered against potential liquidity risks.
Assessment of Liquidity Position
Impact on Liquidity:
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Accounts Receivable: With an increase to R70,000, expecting a 10% growth indicates the potential for higher sales, but it may also mean that cash isn’t realized quickly.
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Inventory: An increase to R90,000 with a reduced holding period indicates improved efficiency in turning over stock to cash.
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Accounts Payable: An increase to R55,000 indicates leveraging supplier terms for better cash flow, thus improving liquidity.
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Short-Term Loans: Up to R25,000 from R20,000 increases financial obligations and can pose future liquidity risks unless the additional loan serves productive purposes.
Recommendations for Improving Liquidity:
- Optimize Receivables Collection: Implement stricter credit policies or incentives for early payments to speed up cash inflows.
- Inventory Management: Continue improving inventory turnover rates and analyze stock levels closely to avoid excess inventory.
- Manage Payables Wisely: Maintain good relations with suppliers to derive benefits from extended payment terms, aligning with cash flow needs.
Calculation of Days' Sales Outstanding (DSO) and Days' Inventory Outstanding (DIO)
Days' Sales Outstanding (DSO) Formula: \[ \text{DSO} = \left( \frac{\text{Accounts Receivable}}{\text{Sales}} \right) \times 365 \]
Current Year DSO: \[ \text{DSO}_{2024} = \left( \frac{60,000}{800,000} \right) \times 365 = 27.38 \text{ days} \]
Next Fiscal Year DSO: \[ \text{DSO}_{2025} = \left( \frac{70,000}{800,000} \right) \times 365 = 32.13 \text{ days} \]
Days' Inventory Outstanding (DIO) Formula: \[ \text{DIO} = \left( \frac{\text{Inventory}}{\text{Cost of Goods Sold}} \right) \times 365 \] Assuming Cost of Goods Sold equals sales for simplicity, as no COGS provided; COGS = Sales = R800,000 in this context.
Current Year DIO: \[ \text{DIO}_{2024} = \left( \frac{80,000}{800,000} \right) \times 365 = 36.5 \text{ days} \]
Next Fiscal Year DIO: \[ \text{DIO}_{2025} = \left( \frac{90,000}{800,000} \right) \times 365 = 40.125 \text{ days} \]
Comparison of DSO and DIO between Years
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DSO:
- Current Year (2024): 27.38 days
- Next Fiscal Year (2025): 32.13 days
- Analysis: An increase in DSO suggests that receivables collection may become slower, indicating a potential liquidity concern.
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DIO:
- Current Year (2024): 36.5 days
- Next Fiscal Year (2025): 40.125 days
- Analysis: An increase in DIO points to slower movement of inventory, potentially impacting cash flow negatively.
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Overall Assessment:
- Both metrics indicate longer collection and inventory holding periods moving into the next fiscal year, which could contribute to cash flow issues unless improved upon.
Final Recommendation
To enhance liquidity, the company should focus on streamlining its collection process, managing inventory levels more effectively, and negotiating better payment terms. Regular monitoring of DSO and DIO should be undertaken to ensure ongoing financial health.
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