Page 252 - Cambridge IGCSE Business Studies

Cambridge IGCSE Business Studies Section 5 Financial information and decisions

Reducing trade (or accounts) receivables

Most businesses sell goods to customers on credit. These used to be referred to
as debtors. This means that customers receive the goods but pay for them at an

agreed date in the future, for example 30 days after delivery. A business can reduce

the length of time it has to wait for payment by making sure that customers pay
on time or offering discounts on early payment. By reducing the total of accounts

receivables in this way the business’s cash balances increase and this provides a
possible source of internal funds for capital expenditure.

The amount of finance raised by reducing working capital depends on

the size of the business as larger businesses are likely to have higher levels of
Liquidity: see Chapter 23, inventory and credit sales than small businesses. But reducing the value of
page 288. working capital is risky because it may reduce the business’s liquidity and its
ability to pay short-term debts.

ACTIVITY 19.3

Invicta Engineering (IE) is a small private limited company that manufactures mechanical components. Their main
customers are other businesses which manufacture domestic appliances such as washing machines, vacuum cleaners and
refrigerators.
The owners of IE are considering how to finance the purchase of a new machine. The machine has a capital cost of
$14,000.
The directors of IE want to use internal sources of finance to fund the purchase of the machine. They have asked Kasinda, the
company’s Finance Manager, to provide them with relevant financial data. This is shown in the table below.

250 $000
Raw material inventories 18
Finished goods inventories 12
Trade receivables – over 60 days 4

Trade receivables – 30–60 days 8
Trade receivables – under 30 days 30
Bank balance 14

Table 19.1 Extract from IE’s most recent quarterly financial statements

Notes:
IE holds enough raw material inventories for three weeks’ production.
IE gives customers 30 days’ credit.
The Finance Director has suggested reducing the raw material inventories so that IE only holds enough for one week’s
production. The Operations Director disagrees. He proposes reducing the level of finished goods inventories by 50%. The
Marketing Director disagrees with this proposal.

1 Explain why the directors of IE decided against using any of the current cash balance to finance the purchase of the new
machine.
2 Explain one limitation to IE of the Finance Director’s proposal to reduce raw material inventories.
3 Explain why you think the Marketing Director disagrees with the Operation Director’s proposal for finished goods
inventories.
4 Discuss how the directors of IE might raise the $14,000 from within its working capital.