IV.3. Releasing cash from other assets

(i) Reducing debtors and stocks

The Society's liquidity problem is due above all to the amount of cash blocked by excessively high levels of debtors and stocks. Consider the effect if the Society brought down its average collection period for accounts receivable from the present 117 days to 60 days. Average debtors would be reduced to 1/6 of sales, at 1986-7 target, 25,000. The difference of 20,000 from the present level would be released as cash. Addressing this problem alone would avoid the need for any further overdraft facility, as the bank manager is likely to point out.

A similar effect would come from a faster turnover of stock. If average stockholding in the coming year could be reduced to a quarter of cost of goods sold without affecting sales, then stock would be 30,000. In other words a further 1 (),000 could come off the overdraft by increasing stock turnover to 4 times.

The Society's accountant reports back to the management committee that the present targets could not be financed without eroding profitability. The new target figures of debtors and stock are suggested, and agreed. However, it is estimated that some costs will be incurred in collecting old debts and that a few might need writing off. Further, some stock is obsolescent, and should be sold off at a discount. After further discussion, it is decided that existing debtors could be persuaded to settle within two months but that 2,000 should be written off as debt collection and bad debt costs; and that 10,000 stock will be sold at cost price in November, thereafter keeping stock at 30,000: all other targets to remain the same. The accountant is requested to draw up new projections for comparative purposes.

Cash flow estimates would differ from the original projection as follows:

Figure 11. Fibre Mat society - Cash flow projection 1986-7

Figure 12 Fibre Mat society - Cash flow projection 1986-7 - Revised

Expenditure: Production costs:

· with constant sales, the reduction in stock implies that less new stock will be manufactured. This will be 8,000 at cost, of which 60% is labour—4,800— and 40% materials and other direct costs—3,200. It will be assumed that this reduction will be spread over two months to minimize hardship to the artisans.

Income:

· Sales revenue will be received in the second month after sales instead of the fourth.

· Opening debtors would now pay as follows: 21,500 in October, 21,50{) in November.

The new cash flow projection is shown in Figure 12.

Instead of increasing its financing requirement by more than 50%, the Society can now reduce it by nearly the same amount. The interest expense, based on average month end figures of borrowing, adding 500 per month to allow for interest, would be in round figures 3,550. Comparative profit and loss projections could now be made (Figure 13).

Figure 13. Fibre Mat Society—Projected Profit & Loss Account, Year

Ended 30 September 1987

Although in the revised projection gross profit would be reduced by 2,000 because of selling 10,000 stock at cost, and 2,000 sales revenue would be written off, still the Society would make more profit, because of reducing interest by more than the amount of lost revenue. It would also be considerably more free of pressure of debt.