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Evaluate these two options and recommend which one Pura Cosmetics could use to manage its cash-flow more effectively. - Edexcel - A-Level Business - Question 1 - 2022 - Paper 2
Question 1
Evaluate these two options and recommend which one Pura Cosmetics could use to manage its cash-flow more effectively.
Worked Solution & Example Answer:Evaluate these two options and recommend which one Pura Cosmetics could use to manage its cash-flow more effectively. - Edexcel - A-Level Business - Question 1 - 2022 - Paper 2
Step 1
Option 1 - overdraft facility
Answer
Pura Cosmetics aims for rapid expansion by increasing output to 15,000 units per month. This increased output may necessitate a larger factory and additional raw materials, which would lead to significant cash outflows. An overdraft facility could provide Pura Cosmetics with the necessary working capital to manage these increased expenses.
Furthermore, in December, Pura Cosmetics forecasted a negative cash flow of £3,800. With an overdraft facility, it might maintain liquidity and prevent damaging relationships with retailers, allowing for smoother operations during peak production periods.
Step 2
Option 2 - reducing the credit period to its customers
Answer
Currently, Pura Cosmetics extends a one-month credit term to its 30 retailers. By reducing this credit period, Pura Cosmetics can improve cash inflows as retailers would pay faster. For instance, by shortening the trade credit period, the company could potentially receive £63,000 sooner, which could alleviate its forecasted negative cash flow in January. Moreover, this change would mitigate interest costs associated with any overdraft used during cash shortages.
Step 3
Recommendation
Answer
After evaluating the options, it is recommended that Pura Cosmetics choose to increase its overdraft facility. This option not only addresses immediate cash flow needs but also provides flexibility to respond to unforeseen expenses associated with production scaling.
While reducing the credit period is beneficial, it might not be as crucial given that most of Pura Cosmetics’ retailers are small, and the sudden credit adjustment may affect sales relationships. Therefore, having an overdraft will be more effective in managing cash flow in a dynamic business environment.