Practice Activity 11.5 Maintenance of a partnership’s liquidity

Gaaba and Hapuru contribute ₦700,000 and ₦400,000 respectively to commence a partnership business in April 2018. Based on the partnership agreement, the profits or losses of the business are to be apportioned equally. On 1 April 2018, the following estimates of cash outflows were made by both partners as follows:

i. Purchase of equipment ₦700,000.

ii. Installation of accounting software ₦100,000.

iii. Rent of office space ₦100,000.

iv. Salaries for both partners amounting to ₦60,000 per month.

v. Administrative staff salary ₦20,000 per month.

There are concerns that the partnership firm may not generate sufficient cash inflows during the first year of operations. The total cash inflows are estimated to be ₦800,000. The cash inflows are expected to increase by 30 percent in the next year.

Required: Recommend how the liquidity of the partnership can be maintained.

A suggested solution to practice activity 11.5

Recommendation of maintenance of the partnership’s liquidity

In order to ensure that partners withdraw as little as possible and make withdrawals when it is extremely necessary, interest can be charged on withdrawals made by partners from the cash of a partnership business. The interest is calculated on a prorata basis, that is, from the date a partner made drawings from the partnership to the end of the financial year. While interest on drawings is an income to the partnership, it is an expense to the partner who has made withdrawals from the partnership.