The managing director of Smart Ltd a trading company, has just received summary
ID: 2489203 • Letter: T
Question
The managing director of Smart Ltd a trading company, has just received summary sets of statements for 2014 and 2015. Total liabilities and shareholders' equity 1.529 1,662 The finance director has expressed concern at the increase in inventory and debtor levels. (a) Show, by using the data given, how you would calculate ratios that could be used to measure inventory and debtor levels in 2014 and 2015 (b) Discuss how the management of Smart Ltd could exercise control over: (i) Inventory levels (ii) Debtor levelsExplanation / Answer
(a)
(i) Inventory turnover ratio (ITOR) = Cost of goods sold / Average inventory
2014: $1,800 / [$(160 + 200) / 2] = $1,080 / $180 = 6
2015: $1,920 / [$(200 + 250) / 2] = $1,125 / $225 = 5
(ii) Receivables turnover = Sales / Accounts receivable
2014: $1,800 / $375 = 4.8
2015: $1,920 / $480 = 4
(b)
(i) A lower ITOR means that inventory is not getting sold fast enough in 2015 as in 2014. Inventory can turn out faster if sales volume increases, which can be achieved by a better and more effective advertising and product promotion strategy.
(ii) Lower Receivables turnover means that the average time taken to collect cash from customers has increased. This indicates a relatively lax and weak credit collection policy. The firm can rectify the situation by imposing stricter credit norms in form of lower credit days. This will lower the debtors component and improve cash collection situation.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.