. Pretty Lady Cosmetic Products has an average production process time of forty days. Finished goods are kept on hand for an average of fifteen days before they are sold. Accounts receivable are outstanding an average of 35 days, and the firm receives forty-days of credit on its purchases from suppliers.
(a) Estimate the average length of the firm's short-term operating cycle. How often would the cycle turn over in a year?
(b) Assume net sales of $1,200,000 and cost of goods sold of $900,000. Determine the average investment in accounts receivable, inventories and accounts payable. What would be the net financing need considering only these three accounts?
To estimate the average length of the firm's short-term operating cycle, we need to calculate the sum of the average production process time, the average time finished goods are kept on hand, and the average accounts receivable.
(a) Average length of the short-term operating cycle:
Average production process time = 40 days
Average time finished goods are kept on hand = 15 days
Average accounts receivable = 35 days
Short-term operating cycle = Average production process time + Average time finished goods are kept on hand + Average accounts receivable
Short-term operating cycle = 40 days + 15 days + 35 days
Short-term operating cycle = 90 days
To determine how often the cycle turns over in a year, we divide the number of days in a year (365) by the length of the short-term operating cycle:
Number of turnovers per year = Number of days in a year / Short-term operating cycle
Number of turnovers per year = 365 days / 90 days
Number of turnovers per year = 4.06 (approximately)
Therefore, the short-term operating cycle turns over approximately 4 times in a year.
(b) To determine the average investment in accounts receivable, inventories, and accounts payable, we need to calculate the respective values.
Net sales = $1,200,000
Cost of goods sold = $900,000
Accounts receivable = Net sales * Average accounts receivable period
Accounts receivable = $1,200,000 * 35 days
Accounts receivable = $42,000,000
Inventories = Cost of goods sold * Average time finished goods are kept on hand
Inventories = $900,000 * 15 days
Inventories = $13,500,000
Accounts payable = Cost of goods sold * Average credit received from suppliers
Accounts payable = $900,000 * 40 days
Accounts payable = $36,000,000
Average investment in accounts receivable, inventories, and accounts payable is the sum of the respective values:
Average investment = Accounts receivable + Inventories - Accounts payable
Average investment = $42,000,000 + $13,500,000 - $36,000,000
Average investment = $19,500,000
Therefore, the average investment in accounts receivable, inventories, and accounts payable is $19,500,000.
For the net financing need considering only these three accounts, we take the negative of the average investment:
Net financing need = - Average investment
Net financing need = - $19,500,000
Net financing need = -$19,500,000 (negative value)
The net financing need considering only these three accounts is -$19,500,000 (a negative value), indicating a surplus of funds in these accounts.