Albinoni Ltd sells a single product and has annual sales of $200,000 per year. Inventories are held at a constant level and each product is sold at a mark-up of 25%. The average settlement period for trade receivables is 2 months and for trade payables it is 1 month. However, the business is considering changing these periods to 1.5 months and 3 months respectively. These changes are not expected to have any effect on the level of sales or inventories.

What will be the decrease in working capital if the proposed changes are implemented?

Solutions:

At 60 days, avg A.R. =60*$200K/365=$32.8k

At 45 days, avg A.R.=45*$200k/365=$24.7k, a reduction of $8.1k At 30 days, avg

(A.P=30*0.8*$200k/365=$13.2k)

At 90 days, avg A.P.=39.4k, a reduction of $26.2 k

Total reduction in W/C=$8.1k+$26.2k=$34.3k

Can someone please explain to me why we have to multiply 0.8 for the accounts payable? Thank you.