Page 15 - CIMA OCS August 2018 Day 2 Suggested Solutions

SUGGESTED SOLUTIONS

Offer prompt payment discounts

We could look into offering prompt payment discounts to these customers as an incentive to pay
earlier than normal. This will clearly impact on our profit margin, but the benefits of receiving
the cash earlier and the reduction in recoverability risk might be worth it.

Financing of receivables through factoring
Ultimately, to protect against the risk of irrecoverable debt, we could at a future date factor our
receivables under a without recourse agreement. This would in effect mean that we would sell
our outstanding debts to a finance company which would be responsible for recovering the
monies and would take on the risk of recoverability. This would have the effect of immediately
improving our cash flow, although it would be relatively expensive to implement.
Recommendation

In order to cope with what could be rapid growth and to improve processes, I recommend the
recruitment of an additional experienced credit controller be prioritised.

2. Operating Cycle
Impact of expanding the product and customer base on the operating cycle

The operating cycle brings together all elements of working capital - inventory, receivables and
payables.

Inventory
By expanding the product base of Thomas Fine Teas this will lead to additional sales that in turn
may lead to a need to increase inventory of finished goods. However, this will not necessarily
lead to an increase in the average length of time finished goods will remain in stock.
If these new market segments prove to be successful and significantly increases our demand
then it is likely that raw materials inventory will increase and as more raw materials will need to
be held. This may lead to an increase in inventory days but may improve profitability as larger
bulk discounts may be negotiated for ingredients not bought at auction..

Receivables
This proposal involves increasing our customer base by the inclusion of many smaller businesses
than our current customer profile. It can be seen that Thomas Fine Teas receivables days has
been extremely high over the last two years and this may be due to the greater buyer power that
supermarkets can exert over Thomas Fine Teas. Smaller customers would not have such large
power and providing that the measures discussed above are implemented then again this may
reduce the receivables days despite the total receivables being larger.

However, as mentioned above, a key issue will be the increase in recovery risk and the extent to
which we can address that problem.

Payables
Whilst an increase in demand for raw materials will undoubtedly increase the payables figure on
the statement of financial position. It is important to remember that Thomas Fine Teas has
control of when it pays its suppliers, within reason. Therefore it could be argued that the effect
on the operating cycle will be entirely up to the management.

It could continue with its current payment period of 85 days or could choose to pay earlier.
Paying later than 83 days could also be considered as long as this does not threaten the
continuity of supply.

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