To continue with the preceding example, the management of Dude Skis is concerned about the working capital impact of expanding the business by 20,000 pairs of skis, and so it asks the cost accountant for a revised analysis that includes projected working capital costs for the baseline scenario of 50,000 units, and for the highest volume scenario of 70,000 units. The following table presents this information:
|
Number of Skis Sold |
||
|
Number of ski pairs |
50,000 |
70,000 |
|
Total revenue |
$19,000,000 |
$23,940,000 |
|
Profit |
500,000 |
490,000 |
|
Working capital components |
||
|
+ Accounts receivable |
+$1,600,000 |
+$2,400,000 |
|
+ Inventory |
+3,200,000 |
+4,000,000 |
|
Accounts payable |
1,100,000 |
1,300,000 |
|
Total working capital |
$3,700,000 |
$5,100,000 |
The working capital assumptions in the table are that the same proportions of inventory and accounts payable will carry forward from the 50,000 unit activity level to the 70,000 unit activity level. However, the accounts receivable investment is assumed to increase, since the company will be making many of the incremental sales to a new group of retailers who are assumed to pay slower than the current group of retailers.
The working capital analysis reveals that Dude Skis would have to invest an extra $1,400,000 in its business in order to grow to a 70,000 unit level, while earning a somewhat lower profit. Clearly, the company should avoid this expansion, though the 60,000 unit sales level noted in the preceding example has a much better payoff, and should be considered.