Working capital — practice questions

Current assets = 80 + 50 + 20 = **$150k**$ Current liabilities = 90 + 30 = **$120k**$ Working capital = 150 − 120 = $30k positive

Comment: Positive but modest — current ratio 150/120 = 1.25 (acceptable but not strong). $80k stock is large - reduce inventory (4.2.1) could free cash. Overdraft $30k shows short-term borrowing already in use.

Part 1: Calculation

Year 1:

• Current Assets = Inventory + Trade Receivables + Cash = $100,000 +$60,000 + $15,000 = **$175,000**
• Current Liabilities = Trade Payables + Bank Overdraft = $80,000 +$0 = **$80,000**$
• Working Capital = Current Assets - Current Liabilities = $175,000 -$80,000 = **$95,000**$

Year 2:

• Current Assets = $150,000 +$90,000 + $5,000 = **$245,000**
• Current Liabilities = $120,000 +$20,000 = **$140,000**$
• Working Capital = $245,000 -$140,000 = **$105,000**$

Part 2: Analysis and Suggestion

Analysis: Working capital increased from $95,000 to$105,000. However, the company's liquidity position has worsened. Both inventory and trade receivables have increased by 50%, tying up significant cash. Cash has fallen from $15,000 to just $5,000, and the company has had to take on a $20,000 overdraft. This pattern suggests the business might be overtrading – expanding sales rapidly without sufficient working capital to finance the growth, leading to a severe cash shortage.

Suggestion: One way to improve the working capital position is to manage trade receivables more effectively. The company could offer customers a discount for early payment, for example, a 2% discount if invoices are paid within 10 days instead of the usual 30. This would accelerate cash inflows. For instance, if half the receivables ($45,000) were collected 20 days earlier, it would significantly improve the cash balance, reducing the need for an overdraft, even though it would slightly reduce the gross profit margin.