Tutorial $3$: Working Capital Management

Extracts from the recent financial statements of Bold $Co$ are given below:

A factor has offered to manage trade receivables of Bold $C_0$ in a servicing and factor$-$financing

agreement. The factor expects to reduce the average trade receivables period of Bold Co from

its current level to $35$ days; to reduce bad debts from $0\mathrm{.}9\%$ of revenue to $0\mathrm{.}6\%$; and save Bold

Co RM$40,000$ per year in administration costs. The factor would also make an advance to Bold

Co of $80\%$ of the revised book value of trade receivables. The interest rate on the advance would

be $2\%$ higher than the $7\%$ that Bold Co currently pays on its overdraft. The factor would charge

a fee of $0\mathrm{.}75\%$ of revenue on a with$-$recourse basis, or a fee of $1\mathrm{.}25\%$ revenue on a non$-$recourse

basis. Assume that there are $365$ working days in each year and that all sales and supplies are

on credit.

Average ratios for companies with similar business operations to Bold Co$.$ are as follows:

Current ratio

Quick ratio

Inventory days

Trade receivables days

:$1\mathrm{.}7$ times

:$1\mathrm{.}1$ times

:$89$ days

:$60$ days

$\frac{1}{2}$

Trade payables days

Sales revenue$/$net working capital

:$85$ days

: $10$ times

Required:

a$)$ Explain the meaning of the term 'cash operating cycle' and discuss the relationship

between cash operating cycle and the level of investment in working capital. Your

answer should include a discussion of relevant working capital policy and the nature of

business operations.

b$)$ Calculate the cash operating cycle of Bold Co$.($Ignore the factor's offer in this part of the

question$).$

c$)$ Using suitable working capital ratios and analysis of the financial information provided,

evaluate the financial health of Bold Co$.$

d$)$ Calculate the value of factor's offer:

$($i$)$ On a with$-$recourse basis;

$($ii$)$ On a non$-$recourse basis.