Voest ltd is a manufacturer and distributer of mine drilling equipment. All of its customers are in the extraction industry. The technology in the extraction industries has been changing rapidly in recent years. As a result of this rapid change, Voest ltd has been investing significantly in research and development in order to keep pace with the changes in the industry. The company is focused on becoming the market leader in the existing product offering. The company has patented many of its existing products. This was obviously done to protect the companys intellectual property.

Voest ltd has a wide range of products that it manufactures. It manufactures products developed in house and it also manufactures products that have been designed by market leaders. In 2016 Voest entered into an agreement with Steglich ltd. Steglich ltd is based in Munich Germany and it is a global leader in the manufacturing of specialized high carbon content mine drills. Voest ltd obtained the right to manufacture and sell the high carbon content mine drills. The specialized high carbon content mine drills will be distributed in Southern Africa. Voest ltd pays a fixed royalty in Euros for each unit of specialized high carbon content mine drills manufactured and sold. The royalties are paid quarterly in arrears. The specialized high carbon content mine drills have proved to be very successful in South Africa because of the relatively complex geological structure of the Southern African region. The total revenue from the high carbon content specialized drills represents 30% of the total annual revenue of Voest ltd. Voest ltds focus has been primarily on South African customers. However, Voest ltd has also supported the subsidiaries of South African customers that are located in the rest of Africa and the Middle East. The revenues from these foreign subsidiaries constitute about 10% of the total annual revenue. These subsidiaries are also invoiced in Euros.

The mining industry in South Africa has been under a lot of pressure during the past few years. This was caused by the Covid 19 pandemic which caused a muted global economic growth. Consequently, Voest has struggled to grow its revenue over the past three years. A special type of steel is used in the manufacture of specialized high carbon mine drilling equipment. The steel prices have also been very volatile over the past few years, due to the Covid 19 pandemic. Thus, this has also added to the pressure on the companys profit margins.

For Voest working capital management has become very crucial in order to stay afloat. This was as caused by a number of factors. Initially, a significant number of customers have been placing orders at the last moment. This caused Voest to hold larger volumes of inventory in order to meet the unexpected demand from these customers. It is important to note that all Voest ltds sales are on credit. Voest ltd allows its customers 60 days to pay from the invoicing date. A lot of customers have been delaying payments due to cash flow problems. As a result of this Voest ltds bank overdraft has been increasing over the years, such that it has become a permanent source of finance. The interest on overdraft is 10% per annum, compounded monthly. Voest ltd has had no other debt since 2019. Bankers are currently not very willing to grant Voest ltd long-term finance. This is due to concerns about the companys cash flow generation ability and the negative outlook in the mining industry in general.

In order to improve the cash flows; the following two options have been proposed by the management:

The company proposes to offer a 10% settlement discount to all customers that pay within 30 days. This is expected to increase revenue by 5%. The company expects 20% of all customers (by revenue value) to make use of the settlement discount. The introduction of the settlement discount is expected to reduce bad debts by 5%.

This option involves Voest ltd discontinuing the manufacture of specialized mine drilling equipment. Voest ltd would purchase the equipment directly from Steglich ltd. Voest ltd would be granted payment terms of 30 days from the invoice date. The option of purchasing would expose Voest ltd to foreign currency movements. However, the finance manager has advised the board that any exposure to currency movements would be hedged using forward or option contracts.

Extracts from the income statement for the year ended 31 December 2021	2021	2020
2021 2020
R R
Sales	248 230 000	241 000 000
Cost of sales	-157 580 000	-144 400 000
Gross Profit	90 650 000	96 600 000
Bad Debts	-5 100 000	-4 500 000
Depreciation	-19 800 000	-20 100 000
Research and development	-10 200 000	-11 100 000
Other operating costs	-28 750 000	-26 700 000
Operating profit	26 800 000	34 200 000
Finance charges	-12 750 000	-10 800 000
Profit before tax	14 050 000	23 400 000
Extracts from the Balance Sheet as at 31 December 2021.	2 021	2 020
R R
Trade receivables	51 000 000	42 900 000
Total assets	279 900 000	264 900 000
Shareholders equity	152 200 000	142 100 000
Bank overdraft	127 500 000	102 800 000
The inventory balance as at 31 December 2021 is R28 060 000
Evaluate the impact of introducing the settlement discount on the profitability and cash flows of Voest ltd	[15 marks]