Horizon Electronics is a private limited company in Kuala Lumpur, Malaysia. It assembles consumer electronics such as portable speakers and wireless headpho...

(a) The acid test ratio (also called the quick ratio) measures the ability of a business to pay its short-term liabilities using its most liquid assets, excluding inventory. [1 for ability to pay short-term liabilities, 1 for excluding inventory/stock]

The formula is:

\[ \text{Acid test ratio} = \frac{\text{Current assets} - \text{Inventory}}{\text{Current liabilities}} \]

(b) Two reasons why inventory is excluded from the acid test ratio calculation:

1. Inventory may take a long time to sell [1] - Especially if demand is low or the products become outdated, stock cannot be quickly converted into cash when debts are due. For an electronics company like Horizon Electronics, portable speakers and wireless headphones can become obsolete as newer models are released, making existing stock even harder to sell quickly. [1]
2. Inventory value may not reflect realisable price [1] - The value shown on the balance sheet is based on cost or expected selling price, but in practice, if stock must be sold urgently, it may only achieve a much lower price. This is particularly true for consumer electronics, which lose value rapidly as technology advances. [1]

(c) Late payments from retail customers could affect the financial stability of Horizon Electronics in several ways:

• Inability to pay own suppliers: If the key retail customer delays payment, Horizon may not have enough cash to pay its component suppliers within the 30-day payment terms. This could damage supplier relationships, lead to tighter credit terms, or even cause suppliers to refuse further deliveries. [1-2]
• Need for costly borrowing: A persistent cash shortage may force the company to use an overdraft or short-term loan to cover immediate obligations. Overdrafts carry high interest rates, which increase costs and reduce profitability. [1-2]
• Production disruption: If component suppliers withhold deliveries because Horizon has not paid on time, production schedules could be disrupted. This would lead to unfulfilled orders from other customers, further reducing revenue and damaging the company's reliability reputation. [1-2]

(d) Whether Mei Lin should offer a discount to the retail customer for early payment:

Arguments for offering a discount:

• Receiving payment earlier improves cash flow immediately, allowing Horizon to pay its own suppliers within the 30-day period and avoid the damaging consequences of late payment. [1-2]
• It reduces the risk of the debt becoming a bad debt if the customer's own financial position is uncertain. [1]
• It signals flexibility and a constructive approach to the commercial relationship. [1]

Arguments against offering a discount:

• A discount reduces the revenue received per sale, lowering profit margins on those transactions. [1-2]
• The retail customer may come to expect discounts on all future invoices, permanently reducing Horizon's income from this customer. [1]
• The underlying problem may be the customer's own cash flow difficulties. A small discount may not be sufficient incentive to change their payment behaviour. [1]

Conclusion: Offering a discount could be worthwhile as a short-term measure to unlock the cash needed for supplier payments. However, Mei Lin should set a clear time limit on the offer (for example, 2% discount for payment within 10 days) and review whether the customer is reliable enough to warrant continued trading on these terms. If the late payment pattern continues despite the discount, Mei Lin should consider whether the relationship is commercially viable and explore alternative customers or tighter credit control measures. [7-8 marks for well-justified evaluation; 4-6 for reasonable analysis; 1-3 for basic points]