Purchasing and Financing 2024

CATS Program
Commercial Advancement Training Scheme
Purchasing- and Financial Management
For 2 nd year CATS learners.
Aligned to the outcomes of the
German accredited certification:
“Industrie Kaufmann/frau”.
Author:
Jacques de Villiers
2 nd Edition, Johannesburg, January 2024
1

Contents
CATS Program .......................................................................... 1
Commercial Advancement Training Scheme ............................ 1
PART A. PURCHASING MANAGEMENT ........................................ 3
1. THE IMPORTANCE OF THE PURCHASING DEPARTMENT ...... 3
2. THE LEVERAGE EFFECT OF PURCHASING .............................. 3
3. SELECTING THE BEST SUPPLIER ............................................. 4
4. PURCHASING COSTS .............................................................. 7
5. STOCK CLASSIFICATION BASED ON TURNOVER .................... 9
6. JUST IN TIME PURCHASING ................................................. 11
7. ORDERING SYSTEMS ............................................................ 13
8. STOCK INDICATORS .............................................................. 17
9. MINIMISING INVENTORY COSTS ......................................... 18
10. MAKE OR BUY DECISIONS ................................................. 20
11. THE PURCHASING ROUTINE ............................................. 22
12. FORMATIVE ASSESSMENT ................................................ 23
PART B. FINANCIAL MANAGEMENT .......................................... 26
1. THE IMPORTANCE OF FINANCIAL MANAGEMENT .............. 26
2. FINANCIAL TERMINOLOGY .................................................. 26
3. THE CASH CYCLE ................................................................... 28
4. CAPITAL REQUIREMENT PLANNING .................................... 30
5. SOURCES OF FINANCE ......................................................... 32
6. CREDITWORTHINESS ............................................................ 35
7. LOAN REPAYMENT ............................................................... 36
8. FINANCING RULES ................................................................ 38
9. CREDIT SECURITIES .............................................................. 39
10. FINANCIAL RATIOS ............................................................ 42
11. FUTURE AND PRESENT VALUE .......................................... 51
12. FORMATIVE ASSESSMENT ................................................ 53
2

PART A. PURCHASING MANAGEMENT
1. THE IMPORTANCE OF THE PURCHASING DEPARTMENT
Students must be able to describe the objectives of the purchasing department.
A purchasing decision starts with the recognition of a need. Once a need is recognised it
must be accurately described so that the correct item can be bought the first time. It’s a
waist of money to buy unneeded items or to buy the wrong item, because it was badly
described.
Supplies must be well managed by the purchasing department so that, when needed,
supplies of the right quality are readily available in the right quantity. The four key
performance indicators are:
o Quality (Supplies must be good enough to be used for their purpose)
o Quantity (Enough of an item must be available)
o Availability (Supplies must be available when needed)
o Accessibility (It must be easy to take delivery of the supplies)
If the key performance indicators are in place, then the user departments will be happy
with the purchasing department, but cost will always be of concern for senior
management and so the Purchasing Manager will always have to keep an eye on cost,
whiles not compromising on the four key performance indicators.
2. THE LEVERAGE EFFECT OF PURCHASING
Students must be able to illustrate the leverage effect of purchasing by calculating the
increase in profit percentage caused by a reduction in the purchase price of the article.
EXAMPLE:
An item is bought for R1 500-00 and sold for R2 000-00 rand while the operating cost
amounts to R300-00. What will the effect be on the % increase in Net Profit if the
Purchasing manager can?
o A: Reduce the purchasing costs by 2.5 %
o B: Reduce the purchasing costs by 5 %
o C: Reduce the purchasing costs by 10 %
Remember that: Gross Profit = Sales Income – Cost of Sales
Net Profit = Gross Profit – Operating Cost
3

ANSWER:
A B C
Sales Income 2 000,00 2 000,00 2 000,00 2 000,00
-Cost of Sales 1 500,00 1 462,50 1 425,00 1 350,00
=Gross Profit 500,00 537,50 575,00 650,00
-Operating Costs 300,00 300,00 300,00 300,00
=Profit 200,00 237,50 275,00 350,00
% Increase in Profit 0 % 18,75 % 37,5 % 75 %
How did we get to a purchasing price of R1462-50 in case A?
1. A 2.5% reduction in the price was negotiated.
2. Thus, the price reduction is 2.5 /100 x 1500 = R37-50
3. R1500-00 – R37-50 = R1462-50
How did we get to a percentage increase of 18.75% in case A?
1. Before the price reduction the Net Profit was R200-00
2. After the price reduction the Net Profit is R237-50
3. Thus R237-50 – R200-00 = R37-50
4. R37-50/R200-00 x 100 = 18.75%
3. SELECTING THE BEST SUPPLIER
Students must be able to select the best supplier from a range of suppliers by setting
criteria and using a decision matrix.
The most general factors you would consider when selecting a supplier are:
o The price of the goods
[PRICE]
o The quality of the goods
[QUALITY]
o Their ability to deliver the quantity you require [QUANTITY]
o Their ability to deliver the goods when you want it [TIME]
You might also consider other factors like …
o Their reputation
o Their BBBEE compliance
o Their reliability etc
4

Quality
Regarding quality, you must realise that it is not always the best quality that is needed as
illustrated in the case below.
When you manufacture toy cars and have to purchase little tires you would not buy tires
made from the same material as Formula 1 tires or tires made out of rubber that is
normally used for planes. Tires of normal rubber that lasts for two years would be good
enough because the quality of the toy cars does not justify the use of expensive rubber.
The proper quality means the quality that is required for the need and that is not always
the best quality. It does not make sense to use screws that will last for 20 years when the
other parts will only last for 3 years.
Price
Regarding price, you must realise that the quoted price doesn’t give the full information
as there are different ways of payment and different price components that have an
impact in the total amount that has to be paid at the end.
Ask the following questions when you obtain a quotation for goods:
o Do I have to pay before, on, or after delivery?
o Are insurance costs included in the price?
o Is delivery included in the price?
o Does the quoted price include VAT?
o Do I qualify for any cash or bulk discounts?
EXAMPLE:
You manufacture sandals for tourists visiting the Kruger Park. It is now mid October and
the main season will start at the beginning of December. The sandals are produced from
leather in different sizes.
The requirements for the leather are:
1. The quality has to be good, according to SABS Standard B
2. They need 500 kg for the start and the option to re-order 100 kg from time to time.
3. The total consumption is estimated at 1 000 kg.
4. The first order must be delivered on 1 November and the rest at short notice.
5. The total price must be competitive and he is prepared to pay cash.
Option A
Alpha Leather has the reputation of producing high quality (A). They always deliver 250kg
bags in two days (guaranteed). There is no possibility to order less. The delivery costs are
R50 and the price per kg is R5. There is a 5 % cash discount available.
5

Option B
Beta Leather produces B quality leather. They deliver the quantity as requested; their
delivery time is normally 2 weeks, but it can also take up to 4 weeks. There are no delivery
costs. They offer 50kg bags at R225 a bag. They give no cash discount, but if you order
more than 1 500 kg you get a R50 refund.
Option C
Gamma Leather offers B quality leather in 100 kg bags at R470 a bag, but one can
purchase less. The delivery cost is R100, but that will be refunded it more than 750 kg is
purchased. They give a 2% cash discount and delivers between 2 and 5 days.
Step 1: Identify the Criteria against which you are going to measure the suppliers.
Quality - B grade leather required.
Quantity - 500kg is needed initially.
- 100kg is needed on five occasions after that
Delivery Time - The initial quantity must be delivered within two weeks.
- The rest must be delivered on short notice
Price - The price must be competitive.
- All price components must be considered.
Step 2: Measure the suppliers against the Criteria and award a percentage mark in each
case.
Quality
o Alpha provides grade “A” quality, while you require only grade “B”. They exceed
your requirements and will score 100% for Quality.
o Beta provides the “B” grade quality that you require; therefore, they will also score
100% for Quality.
o Gamma also provides the required “B” grade and will also score 100% for Quality.
Quantity
o Alpha can deliver the initial 500 kg as required. They can not deliver less than 250
kg at a time. They will score about 75% for Quantity.
o Beta delivers as requested and will therefore score 100% for Quantity.
o Gamma will be able to meet your quantity requirements and will also score 100%
Delivery Time
o Alpha guarantees delivery within two days and will score 100% for Delivery Time.
o Beta should just be able to deliver the initial 500 kg in time, but will not be able to
deliver anything on short notice. They will score no more than 40% for Delivery
Time.
o Gamma will be able to meet the initial requirement and can deliver on short notice
to a degree but can not guarantee it. They will score about 75% for Delivery Time
6

Price
Before one can measure the suppliers against “Price” the total cost for each supplier will
have to be calculated.
Alpha
R5/kg for 1000kg R5000-00
- 5% discount for cash - R250-00
+ 3 Deliveries at R50 +R150-00
R4900-00
Beta
R250/50kg for 1000kg R5000-00
- No discount for 1000kg - R 0-00
+ No delivery cost +R 0-00
R5000-00
Gamma
R470/100kg for 1000kg R4700-00
- 2% discount for cash - R 94-00
+ Delivery Cost (refunded) +R 0-00
R4606-00
o Alpha will score about 90% for Price.
o Beta will score about 85% for Price.
o Gamma will score 100% for Price.
Step 3: Weigh the Criteria
A ranking of the criteria must be done and then a weight must be allocated to the
different factors, which are consistent with the priorities. The total sum that can be
allocated is 1 i.e. 100%
In this case the following weighting would be good: Time (0.4), Price (0.3), Quality (0.2)
and Quantity (0.1)
Step 4: Complete the Decision Matrix
Weight Alpha
Points
Weighted
Results
Beta
Points
Weighted
Results
Bombastic
Points
Weighted
Results
Quality 0.2 100% 20.0% 100% 20.0% 100% 20.0%
Quantity 0.1 75% 7.5% 100% 10.0% 100% 10.0%
Time 0.4 100% 40.0% 40% 16.0% 75% 30.0%
Price 0.3 90% 27.0% 85% 25.5% 100% 30.0%
TOTALS 1 94.5% 71.5% 90.0%
Thus, Alpha will be chosen as it scored the highest weighted percentage.
4. PURCHASING COSTS
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Students can explain the different cost elements that contribute to the Inventory
Carrying Costs and Order Costs.
The purchasing manager is expected to ensure a constant supply of the goods, while
keeping the cost to a minimum. To do this a thorough knowledge of the different cost
components associated with carrying inventory is required.
There are two different cost components involved with purchasing, namely the Inventory
Carrying Costs and the Order Costs.
The Inventory Carrying Cost involves all the following costs.
1. Cost related to the physical stock.
o Buying the stock itself
o Buying packaging for the stock
o Insuring the stock
2. Cost related to the storage facility.
o Buy or rent a warehouse.
o Pay property tax.
o Insure the facility.
3. Cost related to stock management.
o Pay those who work in the warehouse - Labour cost.
o Some old stock will be written of - Obsolescence Cost
o Some of the stock will get damaged - Damage Cost
o Some stock will be stolen - Theft Cost
The Order Cost involves all the following costs.
o The cost of putting the stock on board, rail or truck
o The cost of transporting the stock via sea, air, rail or road
o The cost of delivering and unloading the stock at your warehouse
o The cost of ensuring the stock while in transit
(Some of these costs could already be included in the cost price of the stock)
8

5. STOCK CLASSIFICATION BASED ON TURNOVER
Student can carry out an ABC analysis and interpret the results.
The ABC analysis is an instrument to find out which goods have the highest turnover and
groups inventory items according to their importance for the purchasing management.
Vilfredo Pareto, an Italian economist, and political sociologist devised the law of the
'trivial many and the critical few', better known as Pareto's Law, or the 80:20 rule in 1906.
This rule says that, in many business activities, 80% of the potential value can be achieved
from just 20% of the effort, and that one can spend the remaining 80% of effort for
relatively little return.
The 80:20 Rule applies in almost any field, where 20% of the resources produce 80% of
the result. It's vital to understand that the reverse is also true; things that take up 80% of
your time and resources, will only produce 20% of your results.
So, if you have a product range, your effort should go into the 20% that give you 80% of
your sales. The ABC analysis helps you to identify these winners.
A-type items are very important for the company, highly needed and represent a high
stock value. B-type items are still rather important although to a lesser extent than the A-
type. C-type items are the stock of the least importance which means management
should allocate comparatively low attention to it.
In an ABC analysis an enterprise use the following classification:
A-type items: Represents 20 % or more of the total value purchased during a period.
B-type items: Represents 10 % to 20 % of the total value purchased during a period.
C-type items: Represents less than 10% of the total value purchased during a period.
EXAMPLE:
Statistics compiled by the purchasing department, shows the total quantity ordered and
their acquisition-purchasing price (APP) per unit during the previous period.
Item No. Units APP per unit
1 9 000 R20-00
2 10 000 R 3-00
3 5 000 R 1-00
4 2 000 R 1-50
5 1 000 R17-00
You are expected to complete the following table by using this information.
Step 1: Calculate the Value of Purchase for each item.
Value = Quantity x APP
Step 2: Calculate the Total Value of Purchases
Total Value = Value 1 + Value 2 + Value 3 etc.
9

Step 3: Calculate the % Value for each item.
% Value = ( Value n / Total Value) x 100
Step 4: Fill in the result in the correct column.
Item
No.
Value of
purchase
A-Type B-Type C-Type
% Value % Value % Value
1. R180 000-00 76.6%
2. R 30 000-00 12.8%
3. R 5 000-00 2.1%
4. R 3 000-00 1.3%
5. R 17 000-00 7.2%
Total R235 000-00
10

CLASS ASSIGNMENT:
A handcraft shop in a tourist area offers a wide range of articles. To keep an overview of
stock, the owner has decided to buy new stock twice a month. He makes sure that he
always has sufficient stock, but at the same time he wants to avoid overstocking, as he
knows that holding stock costs money.
In the following table you will find the stock card of this shop. Please carry out an ABC
analysis and give him advice.
ARTICLE Purchasing Starting Stock Purchase 1 Purchase 2 End Stock:
Price
Giraffe R220-00 10 - - 1
Zulu masks R120-00 3 15 4 4
Stone sculpture 1 R 30-00 35 20 25 40
Stone sculpture 2 R 18-00 100 85 75 35
Ndebele doll R 9-00 150 120 10 160
Leather Sandals R30-00 35 70 60 10
Hint:
You need to calculate the Turnover Quantity First
Quantity = Starting Stock + Purchases – End Stock
ARTICLE
Value of
Purchase
A-Type
% Value
B-Type
% Value
C-Type
% Value
Giraffe
Zulu masks
Stone sculpture 1
Stone sculpture 2
Ndebele dolls
Leather sandals
Total
Hint:
You are not done with the question! Remember that you still have to advice him.
Advice:
Keep the following general rules in mind when dispensing advice:
“A” goods should be purchased depending on demand (measured by future demand) at
short intervals to reduce capital and interest costs.
“C” goods should be purchased depending on demand (measured by past demand) at
longer intervals to avoid excessive work and to reduce order costs.
“B” goods may be purchased in either of the two ways.
6. JUST IN TIME PURCHASING
Businesses will always try to maintain enough inventory to prevent running out of stock or
to keep production lines moving. There's no greater disaster in a factory than to have a
11

production line close. Similarly, a retailer or wholesaler can lose sales quickly if popular
products are not on the shelf.
On the other hand, keeping too much inventory is expensive. Firms now pay more
attention to inventory costs - and look to their suppliers for help in controlling them. This
often means that a supplier must be able to provide just-in-time (JIT) delivery - reliably
getting products there just before the customer needs them.
Just-in-time relationships between buyers and sellers require a lot of coordination and
may increase the supplier's costs. Most buyers realize they can't just push costs back onto
their suppliers without giving them something in return. Often what they give is a longerterm
contract that shares both the costs and benefits of the working partnership.
A key advantage of JIT for business customers is that it reduces their physical distribution
(PD) costs - especially storing and handling costs. However, if the customer doesn't have
any backup inventory, there's no "security blanket" if something goes wrong.
If a supplier's delivery truck gets stuck in traffic, if there's an error in what's shipped, or if
there are any quality problems when the products arrive, the customer's business stops.
Thus, a JIT system requires that a supplier have extremely high-quality control in
production and in every PD activity, including its PD service.
To control the risk of transportation problems, JIT suppliers often locate their facilities
close to important customers. Trucks may make smaller and more frequent deliveries -
perhaps even several times a day. As this suggests, a JIT system usually requires a supplier
to be able to respond to very short order lead-times.
The JIT system shifts greater responsibility for PD activities backward in the channel - to
suppliers. If the supplier can be more efficient than the customer could be in controlling
PD costs - and still provide the customer with the service level required - this approach
can work well for everyone in the channel. However, it should be clear that JIT is not
always the lowest cost - or best - approach. It may be better for a supplier to produce and
ship in larger, more economical quantities - if the savings offset the distribution system's
total inventory and handling costs.
The just-in-time approach focuses attention on the need to coordinate the PD system
throughout the channel. It also highlights the value of close working relationships and
effective communication. Whether or not a firm uses the JIT approach, good information
is often the key to coordinating PD activities.
12

7. ORDERING SYSTEMS
After it was determined what to purchase, we need to determine the quantities and the
number of orders to be placed throughout the year.
Constant Inventory Consumption
Students can calculate the Order Level for Constant Inventory Consumption.
If the depletion of inventory takes place at a constant rate, an average inventory
consumption rate can be determined. The inventory level at which we must place an
order, can then be calculated as follows.
Order Level = Safety Stock + (Average Inventory Consumption x Lead time), where
o The Maximum Inventory Size is determined by the size of the warehouse and the
optimal ordering size.
o The Safety Stock is determined by experience, lead time, average inventory
consumption and costs.
o The Average Inventory Consumption is determined by either consumer behaviour
in trade business or average production level in manufacturing business.
o The Lead Time is determined by the suppliers’ facilities.
EXAMPLE:
If the maximum inventory is 120 units, the safety stock 20 units, the average consumption
5 units per day and the lead time 8 days then.
Order Level = 20 + (5*8) = 60 (Meaning that we will place a order when the stock level
reaches 60)
Graphically it could be presented as follows:
120
100
80
60
40
20
0
4 8 12 16 20 24 28 32 36 40
EXAMPLE:
13

Sipho runs a bottle store in Mamelodi. He sells 25 to 30 cases of beer daily. He orders
from the SAB depot in Johannesburg, which is 75 km away. It takes 3 days to deliver the
beer. Occasionally Johannesburg cannot deliver, and then Vereeniging (300 km away)
supplies, but that will take 2 days longer.
You are expected to establish the re-order level and make a recommendation regarding
safety stock.
General Rule: The safety stock should cover the time it takes to deliver if the normal
delivery does not arrive.
Step 1: Establish the safety stock.
Safety Stock = Maximum daily consumption x Maximum delay
= 30 x 2
= 60 cases
Step 2: Establish the re-order level.
Order Level = Safety Stock + (Average Inventory Consumption x Lead time)
= 60 + (27.5 x 3)
= 143 cases
Fluctuating Inventory Consumption
Students can argue the merits of fixed ordering quantity systems and cyclical ordering
systems.
In the case of a constant inventory consumption rate, we ordered the optimal quantity at
the re-order level. When the delivery came in, we were sure that (due to the predictable
depletion) the inventory would be replenished up to the planned capacity.
If there is no such constant inventory consumption, we do not know how many units will
be sold during the lead-time of the delivery. Hence, it may be that we already made use of
our safety stock (increasing consumption) or we still have plenty of stock when the
delivery comes in.
The problem arises to determine the actual quantity ordered under these conditions.
There are two approaches that are applied by companies:
• Fixed Order Quantities System
• Cyclical Ordering System
14

Quantity
A) Fixed Quantities Ordering System
In a fixed quantities system, the optimal order quantity is ordered when the re-ordering
level is reached.
But since consumption is not constant the time intervals between orders will vary greatly.
If consumption slows down the time between orders will increase and if it picks up the
time between orders will decrease.
The advantages of the fixed ordering quantities system is that the most economical
quantity will be ordered whenever an order is placed. This way total purchasing costs are
minimized. Furthermore, this system is very simple to implement, as only the re-ordering
level has to be monitored.
A disadvantage of this system is obvious if the rate of consumption is frequently changing.
If consumption increases dramatically the safety stock could easily be depleted and if
consumption slows down dramatically the maximum stock level could be exceeded on
delivery.
Max Stock
Q2
Q3
Q1
Order Level
Safety Stock
T1 T2 T3
Time
Where Q1 = Q2 = Q3, but T1 ≠ T2 ≠ T3 as...
T1 = Increased Consumption
T2 = Decreased Consumption
T3 = Normal Consumption
15

Quantity
B) Cyclical Ordering System
In cyclical systems, orders are placed at regular intervals, but since consumption is not
constant the order sizes will vary greatly.
If consumption slows down the order quantities will be small, but if consumption pick up
the order quantities will be large. If consumption increases unexpectedly there is a real
danger of running out of stock.
The biggest advantage of this system is that the maximum inventory level will never be
exceeded as it is normally the difference between the maximum stock and the current
stock levels that will be ordered. It is however a more labour-intensive system as the stock
level has to be checked and the order amount calculated before an order can be placed.
Max Stock
Q2
Q3
Q1
Safety Stock
T1 T2 T3
Time
Where Q1 ≠ Q2 ≠ Q3, but T1 = T2 = T3 as...
T1 = Normal Consumption
T2 = Decreased Consumption
T3 = Increased Consumption
16

Deciding which system to choose will differ from case to case but the following general
principles can be used as a rough guide:
o Where the inventory carrying costs and average are relatively low so that only very
few replenishments would be necessary within a year, the cyclical system will be
the best option.
o When inventory consumption is subject to a seasonal demand pattern, the fixed
order quantity system will be the best option as you would be able to order more
regularly during the season of high demand and lower the risk that you might run
out of stock.
o In business with a large range of different products it might be more appropriate
to use the fixed order quantity system as keeping track of all the stock levels and
calculating how much of each product to order could become to labour intensive.
o When the rate of consumption tends to be rather constant, the cyclical system
might dominate the choice, as the risk of running out of stock can be minimised.
8. STOCK INDICATORS
Students can carry out a variety of calculations for stock indicators.
The following table indicates which stock indicator should be used for different
measurements and how they could be calculated.
Indicator Measure Formula
Order Quantity How much to order at a
Annual Use / Number of Orders
time
Average Stock General stock levels ( Order Quantity / 2 ) + Safety Stock
Turnover
Average Storage
Time
Average Storage
Cost
Average Capital
Tied Up
Storage Interest
Rate
How many times old stock
is replenished in a year
How long stock remains in
the warehouse on average
The cost involved in
keeping the stock on hand
Value of the stock on hand
Interest lost on stock on
hand
Annual Use / Average Stock
365 / Turnover
Average Stock x Storage Cost per Unit
Average Stock x Purchasing Price
(Average Storage Time x Interest Rate) / 365
17

CLASS ASSIGNMENT:
A manufacturer requires 1 800 castings per annum with a purchasing price of R100-00.
The storage cost per unit is R10-00 per annum and the safety stock is 10 units.
Calculate the stock indicators as explained in the table above if; Case 1: It is ordered twice
per year and Case 2: It is ordered 12 times per year.
Indicator Case 1 Case 2
Order Quantity
Average Stock
Turnover
Average Storage
Time
Average Storage
Cost
Average Capital
Tied Up
Storage Interest
Rate
9. MINIMISING INVENTORY COSTS
Students can calculate the Optimal Order Size by using a table or by applying a formula.
The core of the inventory problem is this. As the order size increases the number of
orders fall but the average inventory rises. So, costs that are related to the number of
orders will decline but costs related to keeping the stock will rise.
It is worth increasing order size if the decline in order cost outweighs the increase in
carrying cost. The optimal order size is the point at which these two effects exactly offset
each other.
18

There are three ways to find the optimal order size;
o Drawing a graph
o Using a table
o Using a formula
In this course we will only look at the last two methods.
EXAMPLE:
Annual consumption = 1800 units
Cost Price
= R100
Inventory costs = R30 per unit
Safety stock = 10 units
Daily consumption = 5 units
Order costs = R20
Lead time
= 10 days.
Using the table method
Order
quantity
Number
of orders
Cost per
order
Total
order
costs
Average
inventory
level
Average
inventory
costs
Total
costs
1800 1 R20 R 20 910 R27300 R27320
225 8 R160 123 R 3690 R 3850
100 18 R360 60 R 1800 R 2160
60 30 R600 40 R 1200 R 1800
50 36 R720 35 R 1050 R 1770
40 45 R900 30 R 900 R 1800
Thus, the total cost for acquiring and holding stock is minimised at R1 770-00 when 36
orders are placed per year and 50 units is ordered at a time.
Is this however practical in this case?
o 36 Orders per year means three orders per month or an order every ten days.
o Your re-order level will be at 60 units as 10 + (5x10) = 60
o The lead time is also 10 days.
It is clear from the above that you will have to place one order as you take delivery of the
previous order. It will also mean that some deliveries will have to take place over
weekends as your stock will run out if you wait two days.
In this case it seems as if paying a little more for additional peace of mind, might be well
worth it and you might settle for two orders per month which will work out in the region
of R2000-00 per year.
19

Using the formula
If
The Marginal reduction in order cost = (Annual Use x Cost per Order) / Order Size 2
And
The Marginal carrying cost = Carrying Cost per Unit / 2
Then
The optimum order can be found by setting marginal reduction in order cost equal to the
marginal carrying cost and solving Q (The Optimal Order Size) giving us the formula:
Q =
2 x Annual Use x Cost per order
/ Carrying Cost per Unit
In this case
Q =
2 x 1800 x R20
/ 30
Q = 49
An optimum order size of 49 compares very well with the 50 we found when using the
table method but would pose the same practical challenges. In the workplace it would be
much better to use either the table or the formula to choose between several practical
options.
10. MAKE OR BUY DECISIONS
Students can graphically determine whether making or buying would be more cost
effective.
After the company has determined the type and quality of the components of its
products, it has to decide which of these parts shall be purchased through the supplying
markets and which to produce within the company itself. The decision will be taken by
assessing the cost of production on the one side and comparing it with the cost of
purchasing on the other side.
The cost of production consists of the cost that arise from fixed investment into the
required technology (depreciation, rental, maintenance) and the variable costs that occur
due to the consumption of the required raw materials.
The costs of purchasing are determined by the acquisition purchasing cost itself, the
ordering costs and the inventory carrying costs involved with the required part.
20

Cost (R)
The decision whether to make or buy will depend on the required quantity. If only a small
quantity is needed it would be better to buy, but as larger quantities are required the cost
of investment will be offset against the cheaper unit prices of the parts and making could
become the better alternative.
The quantity at which it would be equally advantages to make or buy is known as the
“Break even point”. Any quantity beyond this point would suggest a Make-decision while
any quantity below this point will suggest a Buy-decision. As this point denotes the
quantity from which the production process breaks even, the technique to determine it is
called Break-Even-Analysis.
A Typical Make or Buy Decision Graph
Cost of Purchasing
Total Production Cost
Variable Production Cost
Fixed Production Cost
Break Even Point
Quantity (Units)
CLASS ASSIGNMENT:
A company wants to decide whether it would pay to produce a certain item at their own
factory or buy it from a supplier. The cost accounting department produced the following
figures:
o The production would require fixed costs of R500 000-00
o Each unit of output would yield labour and material costs of R1 200-00.
o The required item is available for R1 500-00 in the market.
21

1. Draw a diagram that contains the graphs of:
o the fixed costs of production
o the variable costs of production
o the total costs of production
o the cost of purchasing
2. Determine the quantity that satisfies the condition:
Cost of Purchasing = Cost of Production
Apart from this calculation, other factors must also be considered.
Factors in favour of buying
o Supplier know-how
o Demand is not constant.
o No fixed workforce
o Research constraints
o Storage problems
o Reputation
o Risks
o Decreasing market
Factors in favour of making.
o Desire to integrate plant
operation.
o Direct control over
production/quality
o Design secrecy required.
o Unreliable suppliers
o Future potential
o Potential competitors not enabled.
11. THE PURCHASING ROUTINE
The following routine is only one type of model. A company will use a system that is
adapted to its needs.
STEP 1:
STEP 2:
STEP 3:
STEP 4:
STEP 5:
STEP 6:
STEP 7:
STEP 8:
STEP 9:
STEP 10:
STEP 11:
STEP 12:
The order level is reached.
Possible suppliers are identified.
Possible suppliers are rated.
A supplier is chosen.
Goods are ordered.
The warehouse is informed of expected deliveries.
Goods are tracked to ensure they arrive on time.
Goods are received.
Check if address, supplier, number of items and weight is correct and if
packaging is not damaged.
Acknowledge receipt of a delivery note.
Issue a purchaser’s note.
Check the goods for quality and quantity.
22

STEP 13:
STEP 14:
STEP 15:
STEP 16:
Check the “hot list” (list of materials that are urgently needed).
Check the invoice for calculations and content.
Prepare the receiving report.
Send copies to the accounting department, inventory control and the
purchasing department.
12. FORMATIVE ASSESSMENT
CASE STUDY
You decided to capitalise on the African Energy Crises by importing and reselling 4
different Diesel Generator Sets at the following prices:
Item 001 110 KVA John Deer Sound Attenuated Set R 236 000-00
Item 002 110 KVA Perkins Super Sound Attenuated Set R 206 000-00
Item 003 130 KVA John Deer Open Set R 235 000-00
Item 004 130 KVA John Deer Sound Attenuated Set R 250 000-00
The following information was obtained from the warehouse stock card for the previous
month.
Item Starting Stock Received from End Stock
Supplier 12/5
001 5 3 0
002 5 3 4
003 5 3 7
004 5 3 2
Question 1
Do an ABC analyses on your product range and make at least two operational decisions
based on your findings (10)
Question 2
What leverage effect would it have on the 110 KVA John Deer if you were able to
negotiate a price reduction of 15% on it?
You currently get them for R180 000-00 each, you pay your salesmen R15 000-00
commission on each set sold and your other costs amount to about R8 000 per set. (6)
Question 3
You decide to expand your product range to include uninterrupted power supplies and are
especially interested in 1400VA 24V Home UPS Inverter Combinations. Initial market
research indicates that you can expect to sell about 25 of these units per month.
o Supplier 1 (a well-known supplier with an excellent reputation) sells a well known
brand at R7 999-00 with a two year guarantee and can supply up to 50 units per
month free of delivery charges.
23

o Supplier 2 (a new player in the market) sells a lesser-known brand at only R5 999-
00 with a one year guarantee and can supply you with 20 units per month for a
R250-00 delivery charge.
o Supplier 3 (a supplier with a reasonable track record) sells the same brand as
supplier 1, with the same guarantee, at 20% less, including delivery, on condition
that you take at least 30 per month.
Design a decision matrix form that provides for the consideration of at least four factors
and complete it to enable you to choose between the three suppliers. (10)
Question 4
You get more and more enquiries about Solar Panels and decide to import Kyocera KC 16T
panels from a Korean company. Decide whether you are going to order once or twice a
month and then calculate your turnover, average stock time, average capital tied up and
storage interest rate using the information below. Remember that Turnover =
Consumption / Ave Stock, (12)
Interest Rate
Annual consumption
Purchasing price
Safety stock
Inventory costs
Lead time
Order costs
9%
2 400 units
R700 per unit
30 units
R55 per unit
6 days
R500
Interest Rate
Question 5
Explain the difference between Fixed Order Quantity Ordering Systems and Cyclical
Ordering Systems with the aid of graphs (12)
24

Question 6
Study the graph below on MAKE or BUY decisions and answer the questions set.
Costs
(R)
B
D E A
C
Variable Costs of Production
Fixed Costs of Production
Quantity (units)
Label lines A and B, point C and areas D and E. (5)
Explain the relevance of point C (2)
If point C is reached once 1500 units is manufactured, explain the implications for the
company if sales was to decrease from 1650 units per annum to 1390 units. (3)
Question 7
Explain what is meant by the following terms (6)
J.I.T purchasing (2)
Re-order level (2)
Optimal order quantity (2)
Question 8
Outline the purchasing routine followed in your company. (14)
25

PART B. FINANCIAL MANAGEMENT
1. THE IMPORTANCE OF FINANCIAL MANAGEMENT
Financial management is the area of business management, devoted to a thoughtful use
of capital and a careful selection of sources of capital, to enable the business to achieve its
goals.
The Financial Management Department is responsible for.
o Contributing to the overall business management.
o Properly allocating and utilising the company’s capital resources.
o Carefully evaluating and selecting the sources of capital.
o Ensuring the achievement of business objectives.
Financial management can be categorised into two broad functional categories namely,
recurring finance functions and periodic finance functions.
Recurring finance functions include.
o Financial planning
o Assessing funds requirement
o Identifying and sourcing funds
o Allocation of funds and income
o Controlling the use or utilization of funds.
Periodic finance functions include.
o Preparation of financial plans to promote the business enterprise.
o Doing financial readjustment during a liquidity crisis
o Valuating the business at the time of a merger or reorganisation
o Other periodic activities of great financial importance
2. FINANCIAL TERMINOLOGY
Anybody working in the finance department of a company must have a working
understanding of the terms used in this department on a day-to-day basis.
Assets, liabilities and owners' equity are the three components that make up a company's
balance sheet. The balance sheet, which shows a business's financial condition at any
point, is based on the equation: Assets = Liabilities + Owners' Equity
Assets
An asset is anything of value that your company owns, including cash.
Assets get recorded on the balance sheet in terms of their monetary values. Remember,
even if you used credit to purchase an asset, you still own it and its full value gets
recorded on one side of the balance sheet as an asset, while the amount you owe gets
recorded on the other side of the balance sheet as a liability.
26

Current assets are assets with amounts that changes continually and include.
o Cash (Including money in the bank)
o Accounts receivable
o Inventory
o Raw materials
Investments are securities owned by the business and include stocks and bonds.
Capital assets are permanent things your company owns and include;
o Land
o Buildings
o Equipment
o Vehicles
Computers, furniture and appliances are also capital assets as long as they remain for use
within your business and are not items you sell.
Intangible assets are patents, copyrights and other nonmaterial assets that have value.
Liabilities
Anything a company owes to people or businesses other than its owners is considered a
liability.
Current liabilities generally refer to a liability that must be paid within a year. This
includes bills, money you owe to your vendors and suppliers, employee payroll and shortterm
loans.
Long-term liabilities refer to any debt that extends beyond one year, such as a mortgage.
Owners' Equity
Owners' equity, also called capital, is any debt owed to the business owners. For example,
if you invested R50 000 of your savings to start a business, that amount is recorded in a
capital account, also referred to as an owners'-equity account.
Working capital
Working capital is a measurement of an entity’s current assets, after subtracting its
liabilities. Generally speaking, companies with higher amounts of working capital are
better positioned for success. They have the liquid assets needed to expand their business
operations as desired.
Sometimes, a company will have a large amount of assets, but have very little with which
to build the business and improve processes. This can occur when a company has assets
that are not easy to convert into cash.
27

Changes in working capital will impact a business’ cash flow. When working capital
increases, the effect on cash flow is negative. This is often caused by the liquidation of
inventory or the drawing of money from accounts that are due to be paid by the business.
On the other hand, a decrease in working capital translates into less money to settle
short-term debts.
3. THE CASH CYCLE
Students can describe the cash cycle and are able to distinguish between Income vs.
Cash Inflow and Expenses vs. Cash Outflow, as well as Financing vs. Investments.
Sometimes referred to as a cash conversion cycle, the cash cycle has to do with the
amount of time that passes between the purchase of raw materials for the creation of
goods and services and the receipt of payment for those products. A key factor in the idea
behind calculating the cash cycle is to understand the period of time when working capital
is not available for use in other purchases.
In a manufacturing process, the cash cycle begins with the acquisition of the materials
needed to produce finished goods. The cycle continues through the time required to
utilize the materials to create the products, package them, and deliver them to customers.
Once the client is invoiced for the delivered goods, the last step of the cash cycle begins. A
cash cycle is considered complete when the Accounts Receivable department receives and
posts payment in full on the invoice covering the delivered goods.
The duration of a cash cycle will vary, depending on several factors, including;
o The amount of time that is required to create the product
o The amount of time spent inspecting, packaging and shipping the finished product
o The amount of time that it takes for the client to remit payment for the finished
goods
A short cash cycle is the ideal situation, as it allows the company to take advantage of the
working capital sooner rather than later. Two ways to shorten a cash cycle are;
o To refine the manufacturing and shipping procedures
o To offer incentives to the customer to pay for the goods quickly
The activities of a company relate to the cash flow as follows:
o Goods are purchased and consequently there’s an outflow of money
o While the goods are combined in the production process, there’s no inflow of
money
o The finished goods must now be sold and waiting for the customer to pay takes
time so that the inflow of cash is delayed
28

It is important to note that Income and Expenses are not equal to Cash Inflow and Cash
Outflow as illustrated by the following table.
Income Expense Cash Inflow Cash Outflow
Customer buys on credit X - -
Customer pays cash X X
Customer pays his instalment - - X
Land is bought X - -
When a company makes a profit there will be sufficient cash inflow in the long run, but
there is a time lag between the outflow and inflow of money. Bridging that time gap is the
task of financing.
Financing is the supply of funds to pay for the investments of the enterprise. Funds may
be needed for:
Short-term liquidity such as:
o trade credits
o salaries and wages
o cash payments
o rental
Long-term investment such as:
o fixed assets
o stocks
o research an development
Investment on the other hand is the application of funds to purchase and maintain the
company’s assets, and may be necessary for:
o The foundation of an enterprise
o Reinvestments such as:
o repairs and maintenance
o replacement of depreciated capital goods
o The rationalization and modernization of the company
o The increase of the company’s operating capacity
CLASS ASSIGNMENT:
Please indicate which of the following is an investment or a form of finance:
o bank overdraft
o car
o machinery
o mortgage
o share capital
o stock
o owner’s equity
29

4. CAPITAL REQUIREMENT PLANNING
Students can draw up a capital requirement plan and a cash flow statement.
There are two key questions to answer when planning a company’s capital requirements:
Firstly:
Secondly:
What must be purchased to initially set up an enterprise and what is the
total amount of money needed for this purpose?
What is the amount of money necessary to operate a enterprise on a dayto-day
basis in order to secure its liquidity at any time?
EXAMPLE:
An inventor developed a new type of plastic lid for bottles. To exploit the invention, he
intends to start his own company. He sets up the following planning:
The lids will have to be produced on two machines and afterwards have to be stored. The
customers will take delivery of their orders at the warehouse.
He will need the following to start the enterprise.
A plot for the company R 500 000
The building premises R2 000 000
Machinery R 400 000
Warehouse equipment R 100 000
Raw materials for 40 days R 50 000
Outstanding Product development loan R 500 000
Total Start-up Capital Required R3 550 000
He will need the following to run the enterprise on a day-to-day basis
Personnel costs
R1 700 per day
Energy costs
R 400 per day
Sundry costs
R 400 per day
Total Running Capital Required
R2 500 per day
If he expects the first payments from clients after 40 days of production, he will require
R100 000 to start running the business.
He will also need to make provision for unexpected situations and keep aside a cash
balance of R100 000 for this purpose.
His total Capital requirement will then be:
R3 550 000 + R100 000 + R100 000 = R3 750 000
30

INDIVIDUAL ASSIGNMENT:
A small company wants to budget for the first few months of its operation. The following
conditions are given:
o Cash purchase of a small truck (R100 000)
o Labour (R10 000) per month
o Monthly rental (R4 000)
o Cash purchase of raw materials R9 000 per month
o Expected sales R126 000 per month whereof
o 1/3 cash
o 1/3 at terms of one month
o The rest at terms of two months.
o The company took a loan of R180 000, which was paid out at the beginning of the
first month, and has to be paid back as follows;
o Instalment of R15 000 per month
o Interest of R2 000 per month
o First payment due on the 15 th of month 3.
QUESTION
Determine the total amount required to finance the first 6 months as well as the amount
needed for each individual month.
Month 1 2 3 4 5 6
CASH INFLOW
Cash Sales
Credit. 1-month
Credit. 2-months
Loan
Total Cash In
CASH OUTFLOW
Truck
Labour
Rental
Material Cash
Material Credit
Interest
Instalment
Total Cash Outflow
Previous Balance
+ Inflow
– Outflow
= Balance
31

5. SOURCES OF FINANCE
Students can distinguish between the different sources of finance
The following table summarises the different sources of finance available to an enterprise.
Internal Sources
Retained Profit Released Profit
(Depreciation)
Owner’s Equity
(Capital
Contribution)
External Sources
Loans
Short Term Longer Term
- Trade Credit - Term Loans
- Overdraft - Debentures
- Bonds
- Shares
After the capital – and cash flow requirements have been calculated, the business’s
owners must decide whether they are going to use their own funds or loan capital to start
the business. As a company is a legal entity separate from its owners both “Owners
Equity” and “Loan Capital” must be regarded as external financing sources. It is only once
a company starts to make a profit that internal sources of finance can be used to grow the
business.
Internal sources of financing (Self Financing)
i. Financing from retained profit.
The profit stays in the company and will be used for investments in additional assets like
machinery. The main advantage is that the money is there and can be used without
borrowing money from the bank and paying additional interest (an expense) to the bank.
The main disadvantage is that the accumulated profits are usually not sufficient for the
whole investments.
ii.
Financing from released capital (Depreciation)
Students can calculate the effect of financing from released capital.
Capital can be “released” by writing off the price of the asset over the expected life span
of the asset (depreciation). Every year an amount is set aside to replace assets at the end
of their life span. This depreciation is added to the annual expenses before the profit or
loss for the year is calculated and will therefore only be possible if the business makes a
profit.
The main disadvantage of this financing method is that it does not take into effect the
replacement costs of new machinery that might be much more due to inflation and
technological change.
32

We can distinguish between the following depreciation methods:
1. The Straight-Line Method
An asset is written of over a certain time and each period during that time is charged at
the same amount as another similar period.
For example: If a R9 000-00 computer is written of over three years, then it will be
depreciated at R3 000-00 per year.
2. Hourly
Some assets’ life expectancy is expressed in hours rather than years or months and
requires that a record be kept of the number of hours the asset is used during each
financial period.
For example: A machine is expected to last for 10 000 hours. The machine is used for 4000
hours in the first accounting cycle, but only for 3000 hours during the second accounting
cycle. It will be depreciated at R4 000-00 for the 1 st cycle and at R3 000-00 for the 2 nd .
3. Declining Balance
In using this method, a constant factor is applied to the reducing book value of the asset.
For example: An asset is depreciated at 25% of its value per year.
EXAMPLE:
Two partners, Peter and John, buy two machines at R50 000 each, that will be depreciated
over five years according to the straight-line method. They make a profit of R100 000 a
year before depreciation and share this among them.
o Their profit before depreciation will be R100 000
o Depreciation will be (2 x R50 000) / 5 = R20 000
o This amount will be indicated as an expense in their income statement
o Their profit after depreciation will be R100 000 – R20 000 = R80 000
o They will each receive R40 000 at the end of the year.
INDIVIDUAL ASSIGNMENT:
You buy 10 machines to start a business with a unit cost price of R75 000 and a life
expectancy of 3 years. Depreciation is calculated according to the straight-line method
and new machines are bought whenever there are sufficient liquid funds available.
Complete the following table:
Year Number of
machines
Depreciation
1
2
3
4
5
6
7
New
Machines
Machines
written off
Liquid Funds
33

External sources of financing
a. Owners’ Equity
Owners’ Equity is what the business owes to the business’s owners. When a company or a
CC is started the amount that is contributed to the business by the owners must be
indicated on the founding documentation.
b. Loan Capital.
1. Short-term credit types
a. Trade Credit
This is one of the most common forms of short-term finance. Goods are bought and
delivery taken, but payment for the goods is delayed between 30 and 90 days
depending on the agreement between the parties.
b. Bank Overdraft
Overdraft facilities allow a company to borrow up to a specified amount on its
current account. The advantage is the great flexibility at peak situations of financial
needs. The disadvantages are the high costs usually associated with an overdraft.
2. Long-term debts
a. Debentures
Debentures involve the issue of a certificate to the creditor stating the conditions of
the loan. The certificate is negotiable and therefore often traded at the stock
exchange. The payment of the debenture, including the interest, is done to the
actual bearer of the certificate. The interest rate is usually fixed as well as the
lending period.
b. Bonds
Bonds are secured loans secured by assets, mostly fixed property. The lending
period is usually very long. The risk involved is moderate because of the security and
the priority a bond has over unsecured loans in case of liquidation.
c. Registered Term Loans
This is an unsecured credit, which, in contrast to debentures, is not negotiable. The
lender and the lending conditions are registered in the enterprise’s books.
Registered term loans can be obtained from banks, venture capitalist and/or
individuals or other institutions.
Aspects to consider when deciding on the different sources of finance to use will include
the repayment period, the interest rate, the impact on management decisions, taxation
etc.
34

6. CREDITWORTHINESS
Students understand the importance of a good credit rating.
Before a loan is approved the creditworthiness of the applicant will be judged. A customer
desiring a loan from his bank makes a loan application after a preliminary verbal
discussion. Many financial institutions use a printed application form with a list of
questions for this purpose. The bank checks the information supplied by the applicant and
builds up an overall picture of his personal creditworthiness and his ability to repay the
loan.
Personal creditworthiness is awarded when the borrower is a reliable person of good
character, hardworking and diligent in his job. The ability to pay the loan is set by the
prescribed financial background, from which a level of credit is assessed.
The following methods are used to evaluate creditworthiness:
Obtaining Information
Information about the customer is obtained mainly from credit rating offices (credit
bureaus). They rely on information and data from their own sources (agents) as well as on
information provided by suppliers. In granting loans to private individuals, the bank
generally also makes use of a credit rating office.
The bank can go further, with due discretion and circumspection, in making use of
references from business acquaintances of the loan applicant. Information is further
provided by trade organizations and associations and is also exchanged between banks.
Examination of public registers
Important conclusions concerning the financial situation and the legal relationships of the
customer can be found in, for example, the land register, the company register and the
property register. In many cases attested certificates and statements will be required of
the customer. For acceptance loans, the (non-public) list of bills protested is essential.
Examination of the bank account
In most cases the borrower has been a customer (by maintaining a bank account with that
bank). The turnover in his account allows conclusions to be drawn concerning the type
and scope of his transactions and his payment history.
Visiting the company
If the borrower runs a business, this provides an overall impression of the state of the
business and of his organization. The important points for a bank are the value of the
stock and machinery.
35

Inspection of the accounts
This primarily concerns the balance sheet and the income statement, for at least the
previous three years. In many cases a financial plan will be called for, to give information
about the prospects for investment and income. Customers not required to keep accounts
will present tax statements, statements of turnover or income receipts.
7. LOAN REPAYMENT
In general, we can differentiate between the following types of loan.
o Fixed rate loans require repayment in a lump-sum with interim interest payments.
o Instalment credit loans require repayment in fixed instalments with reduced
interest.
o Annual fixed sum repayment loans require repayment of a fixed annual sum at
increased redemption, but reduced interest.
It is of cause possible to get a combination of these loan types.
Student can calculate the repayment on a loan.
In the examples and tasks below “Instalment” refers to the amount payable on the
outstanding capital amount.
EXAMPLE 1:
The debt is R10 000, the interest rate is 10 % and the instalment is R2 500. – Then
Year Remaining debt Interest Instalment Total annual
re-payment
1 R10 000 R1 000 R2 500 R3 500
2 R 7 500 R 750 R2 500 R3 250
3 R 5 000 R 500 R2 500 R3 000
4 R 2 500 R 250 R2 500 R2 750
Totals R2 500 R10 000 R12 500
The following should be clear from example 1:
o This is an Instalment Credit Loan
o The sum of the instalments is equal to the original debt
o Borrowing money is costly (R2 500 in interest in this case)
EXAMPLE 2:
The debt is R10 000, the interest rate is 10% and the annual re-payment is R3 000. – Then
Year Remaining debt Interest Instalment Total repayment
1 R10 000 R1 000 R2 000 R3 000
2 R 8 000 R 800 R2 200 R3 000
3 R 5 800 R 580 R2 420 R3 000
4 R 3 380 R 338 R2 662 R3 000
5 R 718 R 72 R 718 R 790
Totals R2 790 R10 000 R12 790
36

The following should be clear from example 1:
o This is an Annual Fixed Sum Repayment Loan
o The sum of the instalments is still equal to the original debt
o The interest is somewhat more in this example.
o There is still an amount of R718 outstanding at the end of year 4
In practice though it is common to find a combination of the two types of loans in that the
loan will be calculated as an instalment credit loan, but repayments will be scheduled as if
it was an annual fixed sum repayment loan.
For example: The total repayment is calculated at R12 500 as in Example 1 and is then
divided by the term (4 years) so that a fixed amount of R3 125 is paid each year.
In the examples given above the interest was calculated per year, but it is common in
practice to calculate the interest on a monthly or even a daily basis and when taking out a
lone you should be aware of the specific terms of the agreement.
INDIVIDUAL ASSIGNMENT:
Complete the tables below for the following cases:
Debt R30 000, interest rate 15 % and instalment R7 500
Year Remaining
debt
1
2
3
4
5
Interest Instalment Total annual
re-payment
Loan R10 000, interest rate 15 % and lump sum repayment payable after 4 years.
Year Remaining
debt
Interest Instalment Total annual
re-payment
1
2
3
4
5
Loan 40.000, interest 10 % and R10 000 annually
Year Remaining
debt
1
2
3
4
5
Interest Instalment Total annual
re-payment
37

8. FINANCING RULES
Students understand the importance of responsible financing decisions.
The decision of how to finance an asset in a company is closely related to its expected
lifetime. Land and buildings are kept as assets for a very long time, while cash funds and
stocks are turned over quickly. Long term financing options should only be used if it will
take long to reconvert the asset into money. Consequently, fixed assets should preferably
be financed by Owner’s Equity, while loan capital should be applied to the financing of
current assets as the returns from sales can then be used to pay the creditors.
The following table explains how Assets and Financing tools should be coordinated:
RECONVERTION INTO ASSETS LIABILITIES REPAYMENT
MONEY
N/A
Cash
Long-term
Fixed Assets Land,
buildings, machinery,
long term claims
Equity capital
Loan capital
Debentures, bonds,
Long-term
Medium to short-term
Current Assets
Stocks, short-term
claims
mortgages
Trade credits, bank
overdraft
Rule: financing long-term assets with long-term means, financing
short-term assets with short-term means
Medium to
short-term
The following approaches to the financing of company assets can be distinguished:
o The Matching Approach where the period for which finance is obtained is matched
with the expected lifetime of the asset. For example, where fixed assets and
permanent current assets are financed with long-term capital.
o The Aggressive Approach where the use of short-term finance is extended to a
part of the permanent current assets (higher risk).
o The Conservative Approach where even parts of the temporary current asset are
financed with long-term capital.
38

9. CREDIT SECURITIES
Students can describe the different forms of securities.
Before agreeing to give a company a loan for any purpose, the creditor will request
securities to guarantee the repayment of the money.
The following diagram shows the major types of credit securities used in South Africa.
Securities
Personal
Real
Simple
Enhanced
- Surety
Immovable
- Mortgage
Movable
- Cession
- Pledge
- Notarial Bond
- Lien
Personal Securities
a. Simple Personal Security
A credit can be secured by the creditworthiness of a person. This is determined by the
financial record of a person or company. Someone with a regular income may qualify for
credit because it is expected that he will be able to repay the money.
The creditworthiness of people, companies and even countries are monitored by different
institutions. They rate the capability of the entity requesting the credit to meet the
financial obligation.
When a debtor defaults on payment it is recorded and the information is passed on to a
Credit Bureau. This can have serious effects on a business as a suppliers who know about
it, may now only be prepared to deliver for cash.
b. Surety
With a surety an individual other than the person requesting the credit is guaranteeing
the payment of the loan. If the actual debtor becomes insolvent, absconds or stops
payment for another invalid reason the guaranteeing person will be held responsible for
the outstanding debt.
39

Real Securities
a. Immovable Securities: The Mortgage
The mortgage is a conveyance of property by the debtor to the creditor as a security for
the debt. It contains the agreement that the property shall be returned on payment of the
debt within a certain period.
The mortgagee (creditor) has the right to sell the property if the mortgagor (debtor) fails
to repay the debt. Once the debt has finally been repaid, the mortgage will be cancelled,
and the owner regains all rights over the property.
b. Movable Securities
1. Cession
A cession is the transfer of intangible assets such as insurance policies, debtors, shares, or
similar certificates to a creditor. The documents in question must identify the creditor as
being the legal holder. The creditor must take actual possession of the assets concerned.
In the case of insolvency of the debtor the creditor has a preferential claim to payment.
2. Factoring
Factoring happens when an enterprise sells its “accounts receivable” to a credit institution
for a specified period. The said enterprise will then have less administration, a better cash
flow and no further contact with its debtors but will lose out on interest receivable and
service fees as these will now be due to the credit institution.
3. Pledge
A pledge is a tangible asset like jewellery or precious metals as a security for a credit. The
director has to actually take possession of the items in question and must execute
uninterrupted control over them. The pledge remains with the creditor as long as the
debtor owes the money and in the case of insolvency the creditor has a preferential claim
over the proceeds of the assets. As all movable assets in a business are necessary to
continue with production the pledge is of little commercial importance.
4. Notarial Bond
The notarial bond may be seen as an equivalent to the mortgage only in connection with
movable goods. It differs though in the degree of security it gives. Other than with a
typical mortgage the creditor cannot automatically auction the property and has no direct
access to the proceeds in the case of insolvency. It only gives the creditor a preferential
claim over other creditors.
The bond must be registered with the Deeds Registry and the property in question
remains in the hands of the debtor. If machinery is bonded in this way, the debtor can
continue production and earn the means to repay the loan.
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5. Lien
A lien is the right to hold somebody’s property until the debt is paid. A garage owner may
hold a client’s car if the client does not collect it after repairs. The creditor has the legal
right to sell the property to recover the money. But it is important to notice that the lien
does not relate to any other debts that the owner of the property may have with the
holder of the lien!
6. Bank guarantee
Where a credit institution assumes liability for a credit given by a third person, it is known
as a bank guarantee. The borrower remains the principal debtor, but the credit institution
is liable if the debts remain unpaid. In return for the guarantee the borrower pays the
bank a commission.
EXAMPLE:
You must decide whether you are going to accept a trade credit or use your overdraft
facility in the following case: You have to pay a supplier R10 000 that is due after 30 days.
Your overdraft interests’ rate is 15% per annum and you are offered a 3% cash discount if
you pay within 10 days.
Solution
Trade Credit: R10 000 due after 30 days
If you pay on day 10 you get the 3% discount and pay only R9 700 but have to use your
overdraft facility.
You will pay the following amount in interest:
R9 700 x 15% / 365 x 20 = R79.73
It is thus worth your while to use your Overdraft facility and take the discount because
you will save R300 – R79.73 = R220.27
GROUP ASSIGNMENT:
Why is it a bad idea to sign surety for a loan for an unemployed friend?
Why is it important to pay your monthly instalments as they fall due?
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10. FINANCIAL RATIOS
Students can calculate and interpret the results of several financial ratios.
Applying Financial Ratios and Accounting Formulas to the financial statements provides
valuable insight into the company's profitability, financial strength, and efficiency of
operations. It can then be used to evaluate both the short-term and long-term prospects
of the business.
The main Accounting Equation is the basis for understanding the financial statements:
Assets = Liabilities + Owner's Equity. From this accounting foundation, each of the
financial statement can be analysed to evaluate various aspects of the business.
When evaluating a business the following are key performance indicators of how well the
business is doing:
o The financial position and Liquidity
o Management Efficiency
o Profitability
o Growth Rates and
o Investment Returns
When evaluating the Financial Condition and Liquidity of a company the following needs
to be calculated:
For the Short-Term Financial Condition and Liquidity
o Current Ratio
o Quick Ratio (Acid Test)
o Working Capital
For the Long-Term Financial Condition and Liquidity
o Book Value
o Debt Equity Ratio
o Interest Coverage Ratio (Income Statement)
o Leverage Ratio
When evaluating the Management Efficiency of an Organisation the following needs to be
calculated:
o Accounts Receivable Turnover
o Average Collection Period
o Asset Turnover Ratio
o Inventory Turnover Ratio
When evaluating the Profitability of an Organisation the following needs to be calculated
o Gross Profit
o Profit Margin
o Net Operating Income
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When evaluating the Growth of a Business the Net Profit Margin must be calculated and
when evaluating the Returns on Investment in a Company, both the Return on Equity and
the Return on Assets must be calculated.
Evaluating the Financial Condition and Liquidity of a company
a. Short Term Financial Condition and Liquidity
Firstly, we must consider whether a business can pay its debts to remain in operation.
Under the Accrual Accounting Method, the revenue is recognized when earned, whether
cash is received as payment. Since sales may be on credit, even profitable companies may
be at risk due to too much debt or a shortage of liquid assets.
To evaluate the short-term financial condition and liquidity of a company we must analyse
the Balance Sheet and calculate the Current Ratio, the Quick Ratio, and Working Capital.
1. Current Ratio = Current Assets/Current Liabilities
This accounting ratio measures the ability of a company to pay its debts over the next 12
months. As a rule, a company should have more than twice the assets to pay debt
obligations, or a ratio equal or greater than two. Anything below one is an indication that
the company may not be able to meet its short-term financial obligations.
Because short-term assets can be quickly turned into cash quickly, it is also a measure of
market liquidity. Ratios that are too high may indicate that assets are not being utilized
efficiently. This is not as concerning as a low ratio but may affect long-term growth.
As with all Accounting Formulas and ratios, each should be compared to the relative
industry and competition. Often each industry has its own standard for acceptable
amounts. For example, luxury items may need a higher ratio during economic downturns
since consumers are less likely to purchase luxury items when budgets are tight.
2. Quick Ratio (Acid Test) = (Current Assets - Inventory)/Current Liabilities
Though inventory is a current asset, it is more difficult to liquidate, and values more
difficult to determine. Products no longer in demand are often liquidated at steep
discounts, which often occur in the retail industry during seasonal changes.
The Quick Ratio, or acid test, is therefore a better measure of liquidity as it only includes
those assets that are more easily convertible to cash (Quick Assets), such as cash
equivalents, receivables, and marketable securities.
A ratio of 1.5 or more is considered adequate to cover short term debts, and a ratio of less
than one is a clear warning signal that a company may not be able to pay its short-term
debts. Industry standards should always be considered when comparing the ratios.
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For example, companies in cyclical industries may require higher ratios to remain solvent
during downturns.
3. Working Capital = Current Assets - Current Liabilities
The Accounting Equation can be rearranged to determine the net worth of the business,
or the amount of assets that belong to the owner debt-free. Similarly, the Working Capital
takes the difference between current assets and current liabilities to measure the
immediate liquidity of the business.
It is mainly used to check current assets that can be converted to cash against current
debts that may be coming due. It provides a comfort level of available resources to pay
current liabilities. A negative result indicates a company may have trouble paying debts
and may be at risk of bankruptcy.
It is more relevant when compared with previous quarters or years. Declining figures may
indicate a decline in sales, and thus a decline in Cash or Accounts Receivable. However, an
increase in the number may indicate operating inefficiency. Increasing Cash Balances may
indicate the company has not utilized cash effectively for growth.
Long Term Financial Condition and Liquidity
1. Book Value
Book Value is one of the simplest and one of the most important measurements of a
company's financial condition. It equals Owner's Equity, or the company's assets minus its
liabilities as listed on the Balance Sheet.
Assets - Liabilities = Owner's Equity
Net Income increases the value of the business, or Owner's Equity, by increasing Retained
Earnings. Although investors often buy and sell on short-term information, it is ultimately
the growing value of the company that determines the successes and failures of
management and the real return on investment.
In publicly traded companies, Book Value is measured as:
Shareholders Equity/Shares of Stock Outstanding
Book Value is what the company is worth if it were liquidated today. For publicly traded
companies, it is compared to the company's Market Capitalization, or market value of all
the company's stock outstanding.
When the share price of a company's stock is low in comparison to the Book Value per
Share, the stock is considered a bargain. Conversely, if the share price is high in relation to
the company Book Value, the stock is considered expensive and possibly overpriced.
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Investors are either expecting an increase in future earnings or are paying too much for
the stock.
2. Debt Equity Ratio = Debt/Owner's Equity
The Debt Equity Ratio is one of the most widely used Financial Ratios. It indicates how
much of the company is financed by debt, the higher the ratio, the higher the debt.
Generally, ratios of higher than 1 indicate more risk in financing assets. As with any
Financial Ratio, owners and investors compare the ratio to the industry average and the
competition.
3. Interest Coverage Ratio (Income Statement) = Operating Income/Interest Expense
The Interest Coverage Ratio measures the ability of a firm to meet its interest payments.
The larger the ratio, the more likely the firm can meet its payments.
The ratio divides Operating Income (income before interest and taxes) by interest
expense.
Analysts typically require minimum ratios of four to qualify for strong credit ratings.
The Software Industry generally has very high profit margins and low debt, creating very
high coverage ratios. The retail industry, on the other hand, has lower profit margins than
software, resulting in less Operating Income to cover interest expenses.
4. Leverage Ratio = Assets/Owner's Equity
The higher this ratio is, the higher the debt. Generally, ratios of higher than 15 are a
warning signal, while low ratios may indicate underutilized assets. It is a handy tool
because it captures all liabilities regardless of where they are listed.
The company either owns an asset (Assets = Owner's Equity) or financed part or all of it
(Assets - Liabilities = Owner's Equity).
For example, if the owner invests $50,000 to start a business in cash, the ratio = 1, as 50
000/50 000 = 1. If the company then purchases machinery for $500,000 on loan, the
Leverage Ratio becomes 11, as 550,000/50,000 = 11. If the business owns $50,000 of the
total assets of $550,000, the total debt must equal 500,000.
To add relevance to this number, compare the ratio with competitors and industry
averages. For example, capital-intensive industries like auto manufacturers have much
higher ratios, while the software industry, which requires much less capital investment,
has lower debt ratios.
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Evaluating the Management Efficiency of an Organisation
a. Accounts Receivable Turnover
Accounts Receivable Turnover allows a company to measure whether or not the company
is effectively collecting payments for sales on credit. A high turnover indicates higher cash
basis sales or efficient collections. A low turnover indicates collection problems and
possible bad debts.
Most companies do not charge interest on Accounts Receivable unless the account
becomes past due. An extension of credit is then essentially an interest free loan to
customers and not collecting payments on time creates inefficiency and opportunity costs
for the company.
For example, the company could use the cash to invest the money and earn interest, pay
down debt from which the company is incurring interest expenses, or finance growth
opportunities instead of having money tied up in Accounts Receivable.
Accounts Receivable Turnover = Net Credit Sales/Average Net Receivables
(Net Average Receivables = (Beginning Net Receivables Balance + Ending Net Receivables
Balance)/2
Alternatively, businesses may calculate Accounts Receivable Turnover in a two-step
process as follows:
1. Average Sales/Day = Credit Sales or Total Sales/365
2. Average Collection Period = Accounts Receivable/Average Sales/Day
The Average Collection Period can then be translated to Inventory Turnover by dividing
the number of days a year by the Average Collection Period,
Inventory Turnover = Number of days a year/Average Collection Period
Add meaning to these numbers by comparing them with the industry averages:
The company should monitor Accounts Receivable balances during the year, and compare
Accounts Receivable Turnover per quarter and per year to ensure turnover does not
decrease from period to period.
b. Asset Turnover Ratio
The Asset Turnover Ratio measures the number of sales generated from each rand of
assets. It is a measure of how efficiently the company has used its assets to generate gross
revenue, the higher the ratio the better.
It is calculated as follows in two steps:
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1. Average Assets for Period = (Beginning Assets + Ending Assets)/2
2. Asset Turnover Ratio = Total Revenue/Average Assets for Period
The next step, as always when calculating any financial ratio, is to add meaning to this
number by comparing it with the industry averages:
Companies with lower ratios tend to have higher profit margins since more assets
required to generate revenue leads to less competition and the ability to raise prices.
Conversely, companies with higher ratios tend to have fewer assets required to generate
revenue, and consequently, less barriers to entry. This leads to more competitive pricing
and lower profit margins.
c. Inventory Turnover Ratio
The Inventory Turnover Ratio is used to determine whether or not a business is
maintaining adequate levels of inventory and is calculated as follows in two steps.
1. Average Inventory = (Beginning Inventory + Ending Inventory)/2
2. Inventory Turnover Ratio = Cost of Goods Sold/Average Inventory
This ratio represents the number of times the inventory is "turned over" during the period
we are measuring. Inventory Turnover is generally higher in the retail industry, with
grocery stores and retailers of perishable goods having the highest ratios, where profit
margins are lower, but sales are made in larger volumes. The ratio should be compared
with competitors and the industry average.
Another calculation, based on the Inventory Ratio, is to determine how many days it took
to clear the inventory. To calculate the number of days, simply divide 365 by the
Inventory Turnover Ratio.
Evaluating the Profitability of an Organisation
a. Gross Profit
Gross profit is the difference between Sales and the Cost of Goods Sold. It is a measure of
a company's core activities and is an early measure of business strength.
Profit Margin = (Sales - COGS)/Sales
A strong profit margin is crucial to business success since it represents profit before
operating expenses and taxes enter the picture.
b. Net Operating Income
The next key income statement item is operating income. This is the income after
deducting expenses that are necessary for operating the business, such as advertising,
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ent, and wage expenses, but before deducting interest and income tax expenses. It’s also
referred to as EBIT (earnings before interest and income taxes) and is a measure of a
company's profitability from operations.
As a percentage of sales, it is called operating margin, and calculated as follows:
Operating Margin = Operating Income/Sales
Both are key measures of how effective a company is at controlling the costs and
expenses associated with its normal business operations.
The 80/20 Principle
The 80/20 Principle was devised by Vilfredo Pareto (1848-1923), to demonstrate that 80%
of wealth comes from 20% of the population. This principle could also be applied outside
economics to just about anything.
When applied to a company’s product line it means that 80% of a company's revenue
comes from 20% of the products. Off cause the 80/20 Principle can also apply to revenue
and expenses. Roughly 80% of your sales may come from 20% of your products. Similarly,
80% of your sales may be supported by 20% of your expenses.
Evaluating the Growth of a Business
The final number to look at on the income statement is net income as.
Net Profit Margin = Net Income/Sales
The Income Statement separates Operating Revenue, revenue generated from the main
operations of the business, from non-operating revenue. The Income Statement also
separates Operating Expenses, those expenses required to support the main operations of
the business, from non-operating expenses. Income Taxes and interest are considered
non-operating expenses.
To evaluate the growth of the company these figures must of cause be compared with
those of preceding periods to see if growth rate is declining or improving.
Evaluating the Returns on Investment in a Company
a. Return on Equity
Return on Equity (ROE) is one of the most important financial ratios in business. It
measures how well a company used Owner's Equity to generate profits and is regarded is
the best indicator of bottom-line performance by some analysts.
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ROE = Net Income/Average Stockholders or Owners Equity
Where: Average Equity = (Beginning Equity + Ending Equity)/2
When a company has a high ROE, it is efficiently using the assets that investors have
provided to it by increasing the equity, or value of the company.
It is important to compare ROE with industry standards. Some industries, such as the
construction industry, require more debt than industries like software, which tend to have
less capital-intensive assets and liabilities.
Companies with low debt levels and high ROE numbers are even more efficient at utilizing
investors' money to increase equity. Technology companies, for example, with clean
balance sheets (low debt levels) often post high ROE numbers due to high profit margins,
not high debt levels.
Because it is difficult to maintain high ROE levels for the long-term, it is also important to
consider ROE over longer periods of time.
b. Return on Assets
Return on Assets shows how effectively a company employed its assets to generate
profits.
ROA = Net Income/Total Assets
Because a company may own or finance its assets, the ratio measures how well a
company has converted all of its resources into profit. It is therefore the most stringent
measure of how well a company has utilized its resources to generate profits. A higher
number indicates a firm more effectively employed its assets to generate profits.
Asset intensive industries such as manufacturing and railroads have much lower
percentages due to a much larger asset base, while the software industry generally has
much higher percentages due to fewer assets required to generate profits.
For this reason, it is important to compare the results with industry standards and
competitors.
High ROA levels may be due to a short - term factors such as one time gains that increase
earnings and ROA, a strong economy or a peak in the business cycle. For this reason it is
important to review a long-term average of ROA:
INDIVIDUAL ASSIGNMENT:
Comment on the Financial Position and Liquidity, Management Efficiency, Profitability,
Growth Rates, and Investment Returns of XYZ Limited Group by calculating the relevant
information in each case.
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XYZ LIMITED GROUP
STATEMENT OF FINANCIAL POSITION at
31-Dec-08 31-Dec-07 30-Jun-08
Reviewed Reviewed Audited
Rm Rm Rm
ASSETS
Property, plant and equipment 68,198 54,394 66,273
Assets under construction 16,366 23,424 11,693
Goodwill 937 607 874
Other intangible assets 911 586 964
Investments in associates 2,102 586 830
Post-retirement benefit assets 781 532 571
Deferred tax assets 1,662 808 1,453
Other long-term assets 3,360 2,408 2,631
Non-current assets 94,317 83,345 85,289
Assets held for sale 31 6 3,833
Inventories 19,190 17,028 20,088
Trade and other receivables 22,605 17,780 25,323
Short-term financial assets 4,401 239 330
Cash restricted for use 1,651 768 814
Cash 21,360 3,956 4,435
Current assets 69,238 39,777 54,823
Total assets 163,555 123,122 140,112
EQUITY AND LIABILITIES
Shareholders' equity 89,638 60,228 76,474
Non-controlling interest 2,142 1,759 2,521
Total equity 91,780 61,987 78,995
Long-term debt 21,224 12,687 15,682
Long-term financial liabilities 48 51 37
Long-term provisions 5,526 3,943 4,491
Post-retirement benefit obligations 4,976 3,992 4,578
Long-term deferred income 354 2,942 376
Deferred tax liabilities 10,247 8,657 8,446
Non-current liabilities 42,375 32,272 33,610
Liabilities in group held for sale - - 142
Short-term debt 1,833 8,671 3,496
Short-term financial liabilities 193 1,318 67
Other current liabilities 27,044 16,971 22,888
Bank overdraft 330 1,903 914
Current liabilities 29,400 28,863 27,507
Total equity and liabilities 163,555 123,122 140,112
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XYZ LIMITED GROUP
INCOME STATEMENT for the period ended
half year half year full year
31-Dec-08 31-Dec-07 30-Jun-08
Reviewed Reviewed² Audited
Rm Rm Rm
Turnover 83,118 55 517 129 943
Cost of sales and services rendered (50 747) (32 042) (74 634)
Gross profit 32,371 23 475 55 309
Non-trading income 454 215 635
Marketing / distribution
expenditure (4 018) (3 226) (6 931)
Administrative expenditure (4 114) (2 986) (6 697)
Other operating expenditure (3 209) (3 468) (8 500)
Operating profit 21,484 14 010 33 816
Finance income 836 273 735
Finance expenses (1 321) (444) (1 148)
Share of profits of associates 233 121 254
Profit before tax 21,232 13 960 33 657
Taxation (8 258) (4 393) (10 129)
Profit for the period 12,974 9 567 23 528
Attributable to
Owners of XYZ Limited 13,216 9 148 22 417
Non-controlling interest in
subsidiaries (242) 419 1 111
12,974 9 567 23 528
Earnings per share Rand Rand Rand
Basic earnings per share 22.17 15.05 37.30
Diluted earnings per share 1 21.79 14.85 36.78
11. FUTURE AND PRESENT VALUE
Students can calculate Future and Present Values to compare different investment
possibilities.
When we invest money, we expect to earn interest on the money invested. So when we
are waiting for payment we are losing money that could have been earned through
interest.
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The future value of an investment is determined by the compounding effect, which means
that the amount of interest earned in each period is added to the amount of the
investment at the end of the preceding period.
EXAMPLE: You have the option of accepting either R1 000 now or R1 500 in three years’
time as payment. If you take the money and invest it at 10% interest, you will have the
following amount in three years:
Year 1: R1 000 + R100 = R1 100
Year 2: R1 100 + R110 = R1 210
Year 3: R1 210 + R121 = R1 331.
At first glance it seems as if it would be better to wait three years and accept the R1 500
as your R1 000 will only compound to R1 331 over the period. However, this does not take
into account the effect of inflation on the buying power of your money. (For the purposes
of these calculations we will ignore the effect of inflation though.)
The compound effect is expressed by the following formula:
FVn = PV (1+ i /100) n
Where PV = Present value (investment), FVn = Future value of the investment after n
periods, i = interest rate and n = number of periods (normally years)
EXAMPLE: If you invest R1 000 at 15% interest for 12 years, then:
FV12 = 1000 x (1 + 15 /100) 12
= 1000 x (1 + 0.15) 12
= 1000 x (1.15) 12
= 1000 x 5.35
= 5350
The formula can also be used to calculate the present value if we know the amount that
will be required after a certain number of years.
EXAMPLE: You sell an asset and know that you are going to need R100 000 in 12 years’
time for university fees for your child and want to know how much you should invest now
at an interest rate of 15%, then:
FVn = PV (1+ i /100) n
So
PV = FVn / (1+ i /100) n
= 100 000 / 5.35
= 18 692
You must invest R18 692 rand now.
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INDIVIDUAL ASSIGNMENT:
You intend to buy government bonds. You are guaranteed that in 10 years’ time an
amount of R200 500 is paid out to you. The constant interest rate is 10 %. How much
money would you need now to buy the bonds?
12. FORMATIVE ASSESSMENT
CASE STUDY
Your nephew Tshepo is finishing matric this year and plans to study a 3-year B. Com at
Wits next year. He will use a R90 000 study loan to pay for his studies. He only must repay
the interest on the loan while he is studying. Once he completes his studies, he will have
to repay the loan in two years.
Question 1
Calculate the following if he negotiates a fixed 15% interest rate for the full term:
7.1 The Cost of the Finance
7.2 The Monthly Repayment while he is studying.
7.3 The Monthly repayment once his studies are completed.
Question 2
Tshepo’s father John realises that they won’t be able to repay the monthly loan amount
from his salary. He decides to open a moving tuck shop, which will visit several local
construction sites, to help him pay for his son’s studies.
• He employs 1 person at R1 500-00 per month.
• He buys a small, second hand, Nissan 1400 bakkie with canopy, to operate the tuck
shop from, for R30 000 from a friend.
• He expects sales of R10 000 in month one and a 10% monthly increase in sales after
that for the first six months.
• His cost of sales is expected to be about 40% of sales.
• His running cost is estimated at R1 000 per month.
• He sells for cash only but has a month to pay his suppliers.
• He borrows R30 000 from the bank to buy the bakkie and must pay back R1 200 per
month, starting in month 2.
Complete a cash flow statement for the first 3 months.
Question 3
John realises that studies are very expensive and that a huge part of Tshepo’s salary will
be used towards the repayment of the loan, once he starts working. He also realises that
the profit from the tuck shop is a bit more than he anticipated and is determined to invest
some of the profits so that they will be able to pay cash for Tshepo’s younger brother
Sabelo first year of study.
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If FV = PV (1+ i/100) n , How much money would he need to invest at an interest rate of
10%, at the end of the year if he requires an amount of R45 000-00 5 years later, when
Sabelo goes to university.
Question 4
The following information was obtained from the financial statements of Creative Plastics
for the years ending 31 December 2007 and 2008 respectively.
Details 2007 2008
Cash sales
Credit sales
Credit purchases
Gross profit
Net profit
R
400 000
1 400 000
450 000
450 000
108 000
R
600 000
1 800 000
550 000
480 000
120 000
Details 2007 2008
Fixed assets
Creditors
Long-term liabilities
Capital
Stock
Debtors
Current assets
400 000
260 000
200 000
440 000
350 000
350 000
700 000
400 000
500 000
-
500 000
500 000
400 000
900 000
Use the information above to calculate the current ratio, acid test ratio and the solvency
ratio for 2007 and 2008. Comment on the financial position of the business based on
each ratio and state the advice you would give the business if any.
What type of business ownership does this company have?
What industry does this business operate in?
If Collection Period = Debtors x 365 / Turnover, how long did this company take to collect
money from creditors in 2008?
Question 5
You buy 5 ovens for your bakery at the beginning of year 1 at R2 000-00 each and they
have a life expectancy of 2 years. Assuming that the business makes a healthy profit,
indicate how you would use depreciation calculated according to the straight-line
method, to finance new ovens from released capital, over a three year period.
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