3.1 Activity Ratios Flashcards

Question

To determine the operating cycle for a retail department store, which one of the following pairs of items is needed? A. Days’ sales in accounts receivable and average merchandise inventory. B. Cash turnover and net sales. C. Accounts receivable turnover and inventory turnover. D. Asset turnover and return on sales.

Answer 1

C. Accounts receivable turnover and inventory turnover. The operating cycle is the time needed to turn cash into inventory, inventory into receivables, and receivables back into cash. For a retailer, it is the time from purchase of inventory to collection of cash. Thus, the operating cycle of a retailer is equal to the sum of the number of days’ sales in inventory and the number of days’ sales in receivables. Inventory turnover equals cost of goods sold divided by average inventory. The days’ sales in inventory equals 365 (or another period chosen by the analyst) divided by the inventory turnover. Accounts receivable turnover equals net credit sales divided by average receivables. The days’ sales in receivables equals 365 (or other number) divided by the accounts receivable turnover.

Answer 2

Inventory Turnover: Decreased Receivables Turnover: Decreased Cost of goods sold is the numerator of the inventory turnover ratio and average inventory is the denominator. A decrease in the numerator accompanied by an unchanged denominator results in a decrease in the overall ratio. Net credit sales is the numerator of the receivables turnover ratio and average net receivables is the denominator. A decrease in the numerator and an increase in the denominator result in a decrease in the overall ratio.

Answer 3

C. Increase the days’ sales outstanding in accounts receivable and increase the cash cycle. With an increased window for accounts receivable and less incentive to pay the balance early, the average collection period is likely to increase. Since days’ sales outstanding in accounts receivable measures the average number of days it takes to collect a receivable, it increases with this change in credit policy. The cash cycle is found by subtracting days’ purchases in payables from the operating cycle. The formula for the operating cycle is Days’ sales outstanding in accounts receivable + Days’ sales in inventory. Since days’ sales outstanding in accounts receivable increases, so does the cash cycle.

Answer 4

B. 3.50 Total asset turnover equals net sales divided by total assets. If the debt-to-total assets ratio is 70% and debt is $1,000,000, total assets must be $1,428,571 ($1,000,000 ÷ 0.7). Given sales of $5,000,000, total asset turnover must be 3.50 ($5,000,000 net sales ÷ $1,428,571 total assets).

Answer 5

increase, increased Inventory turnover ratio for the current year can be calculated as follows: Inventory turnover = Cost of goods sold ÷ Average inventory = $7,000,000 ÷ $5,000,000 = 1.4 times Days’ sales in inventory = 365 ÷ 1.4 = 260.71 * For the prior year: Inventory turnover ratio = $6,000,000 ÷ $4,000,000 = 1.5 times Days’ sales in inventory = 365 ÷ 1.5 = 243.33 Thus, there was an increase in days’ sales in inventory. Receivables turnover ratio for the current year can be calculated as follows: AR turnover = Net credit sales ÷ Ending receivable = $11,000,000 ÷ $4,000,000 = 2.75 times Days’ sales in receivables = 365 ÷ 2.75 = 132.72 For the prior year: AR turnover = $10,000,000 ÷ $3,000,000 = 3.33 times Days’ sales in receivables = 365 ÷ 3.33 = 109.5 Thus, days’ sales in receivables also increased.

Answer 6

B. 81 The operating cycle is the time needed to turn cash into inventory, inventory into receivables, and receivables back into cash. It is equal to the sum of the number of days' sales in inventory (average number of days to sell inventory) and the number of days' sales in receivables (the average collection period). The number of days' sales in inventory is given as 55 days. The number of days' sales in receivable is given as 26 days. Hence, the number of days in the operating cycle is 81 (55+26).

Answer 7

C. 7.3 times. Purchases are calculated as follows: Cost of goods sold $24,500 Plus: Ending inventory 7,600 Goods available for sale $32,100 Less: Beginning inventory (6,400) Purchases $25,700 Palmito’s payables turnover can be calculated as follows: Payables turnover = Purchases ÷ Average accounts payable = $25,700 ÷ [($3,320 + $3,680) ÷ 2] = $25,700 ÷ $3,500 = 7.3

Answer 8

B. 22 days Days' sales outstanding in receivables measure the average number of days it takes to collect a receivable. * Days' sales outstanding in receivables = days in year / accounts receivable turn over. * AR turnover = net credit sales / average accounts receivable. AR turn over is 5.33 {$6 million / [($1 million + $1.25 million) / 2]}. Days' sales outstanding in receivables is 68 days (365 days / 5.33). Thus, the company's accounts receivable collection period is less than the industry average by 22 days (90 days - 68 days).

Answer 9

C. 10.0 times AP turnover ratio = purchases / avg. AP Purchases for the period can be derived from the formula for cost of goods sold (COGS = Beginning inventory + purchases - ending inventory). Thus purchases amount to $250,000 ($270,000 + 40,000 - 60,000). The average accounts payable balance is $25,000 [($30,000 + 20,000) / 2]. Therefore, the accounts payable turnover ratio is 10.0 times ($250,000 / $25,000).

Answer 10

B. $5,000,000 If the debt-to-total assets ratio is 70% and debt is $1,000,000, total assets must be $1,428,571 ($1,000,000 / 0.7). Given total asset turn over (sales / total assets) of 3.5, sales must be $500,000 (1,428,571 x 3.5).

Answer 11

sales / working capital

Answer 12

A. 40.81 days The operating cycle is the time that passes between acquiring inventory and collecting cash for its sale. It is the sum of the days' sales in receivables and the days' sales in inventory. Ben Jonson holds its inventory 72.50 days [$870,000 ending inventory / ($4,380,000 COGS / 365 days)] and its receivable 19.71 days [$335,000 ending accounts receivable / ($6,205,000 net credit sales / 365 days)]. Its operating cycle is 92.21 days (72.50 + 19.71). The cash cycle equals the operating cycle minus the days' purchases in accounts payable (days in year / accounts payable turnover). Consequently, the days' purchases in accounts payable equal 40.81 days (92.21 days in the operating cycle - 51.40 days in the cash cycle).

Answer 13

C. 4.31 times Purchases are calculated as follows: COGS $270,000 Plus: Ending Inventory 70,000 = Goods available for sale = $340,000 Minus: Beginning Inventory ($60,000) = Purchases $280,000 The accounts payable turnover is calculated as follows: Accounts payable turnover = purchases / average accounts payable = $280,000 / [(50,000 + 80,000)/2] = 4.31 times

Answer 14

D. Favorable credit policies. The analyst can conclude that sales increased due to more favorable credit policies. The inventory turnover ratio increased drastically, meaning that COGS increased, average inventory decreased, or both. At the same time, the receivables turnover decreased, meaning average accounts receivable increased. Sales did not decrease; the question stem explains that they increased. The increase in average accounts receivable and the decrease in inventory can best be explained by a more favorable credit policy because this would allow more customers to purchase from the company even if they lack the best credit standings.

Answer 15

A. The company's credit terms with vendors are net 30 days. Since the company's accounts receivable turnover is 8.1, it takes 45.06 days (365 / 8.1) to collect the accounts receivable. The terms of "net 30 days" mean that full payment of vendors' invoice is due in 30 days. The company may have difficulties paying vendors' invoices on time because its collection period is longer than its number of days to settle payables.

Answer 16

B. 55 days. A company's operating cycle is the amount of time that passes between the acquisition of inventory and the collection of cash on the sale of that inventory, which is the same as the days' sales in receivables plus the days' sales in inventory. In this case, the operating cycle is 85 days, consisting of the 40 days in receivables plus the 45 days in inventory. The cash cycle is that portion of the operating cycle that is not accounted for by days' purchases in accounts payable. In this case, the cash cycle makes up 30 of the 85 days in the operating cycle. Therefore, the days' purchases in payables must be 55 days (85 days - 30 days)

Answer 17

Operating profit margin: no change Total Assets Turnover: decrease Return on Assets: decrease An additional investment in operating assets that are financed by debt will cause assets and liabilities to increase proportionally. This transaction would have no effect on income statement balances. Therefore, there will be no change in operating profit margin (operating income / sales). Both the total asset turnover (net sales / average total assets) and the return on assets (net income / average total assets) will decrease as the denominator of these ratios will increase, but the numerator remains constant.

Answer 18

Inventory Turnover: Increase Use of Equity Financing: Decrease Return on equity, in the most general terms, is the ratio of net income to total equity. Increasing inventory turnover raises the numerator, and decreasing equity financing lowers the denominator. This combination is thus the only effective means of increasing return on equity.

Answer 19

A. 4.01 Garland’s inventory turnover ratio can be calculated as follows: Inventory turnover = Cost of goods sold ÷ Average inventory = $527,000 ÷ [($125,000 + $138,000) ÷ 2] = $527,000 ÷ $131,500 = 4.0076 times