Flash Point Bhd is considering making the following changes in the area of working capital management:

Inventory management

Flash Point BAhd forecasts that demand for Product XYZ will be 100,000 units in the coming year. Currently, the company’s policy is to order 20% of annual demand per order. The ordering cost is expected to be RM250 per order while the holding cost is expected to be RM1.80 per unit per year.

The management of Flash Point Bhd is considering to determine the order size for Product XYZ using the economic order quantity model (EOQ).

Receivables management

Flash Point Bhd could introduce an early settlement discount of 1% for customers who pay within 30 days and at the same time, through improved operational procedures, maintain a maximum average payment period of 60 days for credit customers who do not take the discount. It is expected that 25% of credit customers will take the discount if it were offered.

It is expected that administration and operating cost savings of RM753,000 per year will be made after improving operational procedures and introducing the early settlement discount.

Credit sales of the company are currently RM87·6 million per year and trade receivables are currently RM18 million. Credit sales are not expected to change as a result of the changes in receivables management. The company has a cost of short-term finance of 5.5% per year.

Required:

a) Calculate the cost of the current ordering policy and the change in the costs of inventory management that will arise if the economic order quantity is used to determine the optimum order size for Product XYZ.

b) Calculate and comment on whether the proposed changes in receivables management will be acceptable. Assuming that only 25% of customers take the early settlement discount, what is the maximum early settlement discount that could be offered?

c) Following the new policy, the Chairman of Flash Point expect some cash excess . He commented the following statement in the recent management meeting:

“ Two options that we can undertake for any excess of cash is to pay our suppliers more quickly or to reduce our outstanding debt.” Comments on the Chairman statement.

d) Discuss THREE factors that should be considered in formulating working capital policy on the management of trade receivables.