Vanity Press, Inc., has annual credit sales of $1.6 million and a gross profit margin of 35 percent.
a. If the firm wishes to maintain an average collection period of 50 days, what level of accounts receivable should it carry? (Assume a 365-day year.)
b. The inventory turnover for this industry averages six times. If all the Vanity's sales are on credit, what average level of inventory should the firm maintain to achieve the same inventory turnover figure as the industry?
To calculate the answers, we need to use the following formulas:
a. Average Collection Period (ACP) = (Accounts Receivable / Credit Sales) * Number of Days in a Year
b. Inventory Turnover = Cost of Goods Sold / Average Inventory
Let's calculate each answer step by step:
a. Average Collection Period:
Given:
- Credit Sales = $1.6 million
- Gross Profit Margin = 35%
- Average Collection Period (ACP) = 50 days
- Number of Days in a Year = 365
First, we need to find the Cost of Goods Sold (COGS) using the gross profit margin:
Gross Profit = Gross Profit Margin * Revenue
Gross Profit = 0.35 * $1.6 million = $560,000
Revenue = $1.6 million
COGS = Revenue - Gross Profit
COGS = $1.6 million - $560,000 = $1,040,000
Now, let's calculate the level of accounts receivable:
ACP = (Accounts Receivable / Credit Sales) * Number of Days in a Year
50 = (Accounts Receivable / $1.6 million) * 365
To find the Accounts Receivable, rearrange the formula:
Accounts Receivable = (50 / 365) * $1.6 million
Accounts Receivable = $219,178.08
Therefore, Vanity Press, Inc. should carry approximately $219,178 in accounts receivable.
b. Average Level of Inventory:
Given:
- Inventory Turnover (Industry Average) = 6 times
- All Sales are on Credit
We know that Inventory Turnover is calculated as:
Inventory Turnover = Cost of Goods Sold / Average Inventory
Rearrange the formula to find the Average Inventory:
Average Inventory = Cost of Goods Sold / Inventory Turnover
Average Inventory = $1,040,000 / 6
Average Inventory = $173,333.33
Therefore, Vanity Press, Inc. should aim to maintain an average inventory of approximately $173,333 to achieve the industry average turnover of 6 times.