To analyze the working capital needs of XYZ Ltd., we'll follow the requirements laid out using the data provided.
2.1 Compute the Working Capital of XYZ Ltd.
Working Capital can be calculated as the difference between Current Assets and Current Liabilities.
Current Assets:
- Cash: R50,000
- Accounts Receivable: R120,000
- Inventory: R80,000
- Prepaid Expenses: R10,000
Total Current Assets = Cash + Accounts Receivable + Inventory + Prepaid Expenses
Total Current Assets = R50,000 + R120,000 + R80,000 + R10,000
Total Current Assets = R260,000
Current Liabilities:
- Accounts Payable: R70,000
- Short-term Loans: R30,000
- Accrued Expenses: R20,000
Total Current Liabilities = Accounts Payable + Short-term Loans + Accrued Expenses
Total Current Liabilities = R70,000 + R30,000 + R20,000
Total Current Liabilities = R120,000
Now, let's calculate Working Capital:
Working Capital = Total Current Assets - Total Current Liabilities
Working Capital = R260,000 - R120,000
Working Capital = R140,000
2.2 Calculate the Current Ratio and Discuss Whether the Company Meets Its Working Capital Ratio Target
Current Ratio is calculated as the ratio of Current Assets to Current Liabilities:
\[ \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} \]
Using the totals calculated above:
\[ \text{Current Ratio} = \frac{R260,000}{R120,000} \]
Calculating the ratio:
\[ \text{Current Ratio} = 2.1667 \text{ (or approximately 2.17)} \]
Discussion: XYZ Ltd. aims to maintain a minimum working capital ratio of 1.5. The calculated current ratio of approximately 2.17 exceeds the target ratio of 1.5, which indicates that the company is in a good position to cover its short-term liabilities with its short-term assets. This suggests that the company has a satisfactory liquidity position.
2.3 Discuss Ways in Which XYZ Ltd Can Improve Its Working Capital Management
Here are several ways XYZ Ltd. can improve its working capital management:
-
Optimize Inventory Management:
- Reduce excess inventory to improve turnover rates. Implement Just-In-Time (JIT) inventory practices to align stock levels more closely with customer demand and reduce holding costs.
-
Enhance Accounts Receivable Collection:
- Review credit policies and collection procedures. Encourage faster payments by offering discounts for early payment or by tightening credit limits and terms for customers who routinely pay late.
-
Extend Accounts Payable Terms:
- Negotiate better terms with suppliers to delay payment without harming supplier relationships. This extension allows the company to use cash for operational needs in the interim.
-
Increase Sales Revenue:
- Enhance marketing and sales efforts to improve cash inflow. Focusing on high-margin products or targeting new customer segments could help increase the cash available.
-
Review and Control Operating Expenses:
- Conduct regular reviews of operating expenses and identify areas for cost reduction. Streamlined operations can free up cash for working capital.
-
Monitor Cash Flow Regularly:
- Establish a robust cash flow monitoring system to anticipate cash shortfalls and surpluses better, allowing for informed decision-making regarding short-term financing or investment.
-
Consider Short-term Financing Options:
- If necessary, utilize short-term financing to cover any temporary cash flow gaps. Options could include revolving credit lines or advances from financial institutions.
By implementing these strategies, XYZ Ltd. can strengthen its working capital position, support operational needs more efficiently, and ultimately enhance business performance.
1 answer