Operational Activity Measures-Financial Management Flashcards
Selected data pertaining to Lore Co. for the calendar year 2003 is as follows:
Net cash sales $ 3,000
Cost of goods sold 18,000
Inventory at beginning of year 6,000
Purchases 24,000
Which one of the following was Lore's average days' sales in inventory? A. 3 days B. 6 days C. 25 days D. 180 days
D. 180 days
he average days’ sales in inventory is calculated as: 360 days/Inventory Turnover.
Inventory Turnover = COGS/Average Inventory
In this problem, average inventory is BI = $6,000 + EI = $12,000 = $18,000/2 = $9,000.
The EI is BI = $6,000 + Purchases = $24,000 = $30,000 - COGS = $18,000 = $12,000.
Therefore, inventory turnover is COGS = $18,000/Avg Inven = $9,000 = 2.
Then, 360/2=180.
Cyco, Inc. determined the following concerning its operating activities:
Accounts receivable conversion cycle 18 days
Accounts payable conversion cycle 21 days
Inventory conversion cycle 24 days
Which one of the following is the length of Cyco's operating cycle? A. 42 days. B. 39 days. C. 21 days. D. 15 days.
A. 42 days.
The operating cycle is the average length of time between the acquisition of inventory and the collection of cash from the sale of that inventory. It is measured by the inventory conversion cycle + the accounts receivable conversion cycle. Cyco’s inventory conversion cycle is 24 days and its accounts receivable conversion cycle is 18 days. Thus its operation cycle is 24 + 18 = 42 days.
Creditco, Inc. sells goods on credit terms of “net 30 days.” If Creditco has efficient credit policies and collection practices, which one of the following would most likely be its accounts receivable turnover?
A. 10 times per year. B. 12 times per year. C. 24 times per year. D. 36 times per year.
B. 12 times per year.
The formal calculation of accounts receivable turnover (ART), which measures how many times during a year average accounts receivable are collected, is:
ART = Credit Sales/Average Accounts Receivable. Since, in this question, we are told that Creditco has efficient credit and collection, we logically can assume that its collections of accounts receivable is consistent with its credit terms. Creditco’s credit terms of “net 30 days” mean that it does not offer customers a discount for paying early, but that its customers have 30 days to pay the amount due to Creditco.
If Creditco collects amounts due in a timely manner, its accounts receivable should be outstanding for 30 days on average (or would turn over every 30 days). If accounts receivable turn over every 30 days, then 360days/30days = 12 times per year.
Like most ratios, the usefulness of the accounts receivable turnover is enhanced by comparing it with industry averages or with Creditco’s turnover rate over time.
Super Sets, Inc. manufactures and sells television sets. All sales are finalized on credit with terms of 2/10, n/30. Seventy percent of Super Set customers take discounts and pay on day 10, while the remaining 30% pay on day 30. What is the average collection period in days? A. 10. B. 16. C. 24. D. 40.
B. 16.
The average collection period is 16 days, computed as:
Customers paying on day 10 = .70 x 10 days = 7 days average.
Customers paying on day 30 = .30 x 30 days = 9 days average.
Average collection period = 16 days
On average, 70% are outstanding for 10 days and 30% are outstanding for 30 days. By getting the weighted average of each group and summing them, the average collection period is determined.
Which one of the following is not used in determining the operating cycle of an entity?
A. Accounts payable conversion cycle. B. Inventory conversion cycle. C. Fixed asset conversion cycle. D. Cash conversion cycle.
C. Fixed asset conversion cycle.
The fixed asset conversion cycle is not a component used in determining the operating cycle of an entity. The concept of the fixed asset cycle is not commonly used, but when used refers to the period that covers the acquisition, use and disposal of fixed assets. Fixed asset life is not an element included in measuring the operating cycle.
A corporation manages inventory performance by monitoring its inventory turnover. Selected financial records for the corporation are as follows:
Year 1 Year 2 Year 3
Annual sales $1,262,500 $1,062,500 $1,459,000
Gross annual profit percentage 45% 30% 40%
The beginning finished goods inventory for year 2 was 20% of year 2 sales. The ending finished goods inventory for year 2 was 18% of year 3 sales. What was the corporation's inventory turnover for year 2? A. 1.34 B. 2.83 C. 3.03 D. 3.13
D. 3.13
Inventory turnover measures the number of times that inventory is acquired and sold or used during a period. It is calculated as: Cost of Goods Sold/Average Inventory (i.e., beginning inventory + ending inventory/2). In this question, the cost of goods sold is determined using the inverse of the gross annual profit percentage (which is the gross annual cost percentage), or $1,062,500 x (1.0 - .30) = $1,062,500 x .70 = $743,750, the cost of goods sold. The average inventory is determined using the percentage of sales that constitutes inventory as give in the facts. Specifically, year 2 beginning inventory is $1,062,500 x .20 = $212,500 and year 2 ending inventory is $1,459,000 x .18 = $262,620. The average is the sum of beginning plus ending divided by 2, or $212,500 + 262,620 = $475,120/2 = $237,560, the average inventory. Therefore, the inventory turnover is: $743,740/$237,560 = 3.13 - the inventory turned over 3.13 times during year 2.
Each of the following periods is included when computing a firm’s target cash conversion cycle, except the
A. Inventory conversion period. B. Payables deferral period. C. Average collection period. D. Cash discount period.
D. Cash discount period.
The cash discount period is not included when computing a firm’s target cash conversion cycle. The cash discount period is the period of time during which a debtor is offered a discount for early payments of an account and does not establish when cash is actually received. The actual collection of cash could be any time during or after the discount period and it is that actual date of collection that enters into the measurement of the cash conversion cycle.
Cyco, Inc. determined the following concerning its operating activities:
Accounts receivable conversion cycle 18 days
Accounts payable conversion cycle 21 days
Inventory conversion cycle 24 days
Which one of the following is the length of Cyco's cash cycle? A. 42 days. B. 39 days. C. 21 days. D. 15 days.
C. 21 days.
The cash cycle can be determined as the operating cycle (i.e., inventory conversion cycle [24 days] + accounts receivable conversion cycle [18 days]) less the accounts payable conversion cycle [21 days]. Thus, Cyco’s cash cycle would be computed as 24 + 18 = 42 - 21 = 21 days, the correct answer.
The following calculations were made from Clay Co.’s 2003 books:
Number of days’ sales in inventory 61 Days
Number of days’ sales in trade accounts receivable 33 Days
Which one of the following was the number of days in Clay's 2003 operating cycle? A. 33 days B. 47 days C. 61 days D. 94 days
D. 94 days
The operating cycle measures the average length of time to invest cash in inventory, convert the inventory to accounts receivable, and collect the receivables.
Thus, for Clay, its operating cycle is the sum of its number of days’ sales in inventory plus the number of days’ sales in trade accounts receivable, or 61 days + 33 days = 94 days.
Basically, this measures the number of days to go from cash through inventory and accounts receivable, back to cash.
he controller of Peabody, Inc. has been asked to present an analysis of accounts receivable collections at the upcoming staff meeting. The following information is used:
12/31, year 2 12/31, year 1
Accounts receivable $100,000 $130,000
Allowance, doubtful accounts (20,000) (40,000)
Sales 400,000 200,000
Cost of goods sold 350,000 70,000
What is the receivables turnover ratio as of December 31, year 2? A. 5.0 B. 4.7 C. 3.5 D. 0.6
B. 4.7
Correct!
Accounts receivable turnover is calculated as: (Net Credit) Sales/Average Net Accounts Receivable.
In this question, it is first necessary to compute average net accounts receivable.
Average Net Accounts Receivable = [Beginning Net Accounts Receivable ($130,000 - $40,000 = $90,000) + Ending Net Accounts Receivable ($100,000 - $20,000 = $80,000)]/2 = ($90,000 + $80,000 = $170,000)/2 = $85,000
Accounts Receivable Turnover = $400,000/$85,000 = 4.705
Which one of the following constitutes (measures) the operating cycle of an entity?
A. Accounts payable conversion cycle + accounts receivable conversion cycle.
B. Inventory conversion cycle + accounts payable conversion cycle.
C. Inventory conversion cycle + cash conversion cycle.
D. Inventory conversion cycle + accounts receivable conversion cycle.
D. Inventory conversion cycle + accounts receivable conversion cycle.
The operating cycle measures the average length of time between the acquisition of inventory and the collection of cash from the sale of that inventory. It is measured by the inventory conversion cycle + the accounts receivable conversion cycle.
Which one of the following measures would be least appropriate in evaluating working capital management?
A. Inventory turnover ratio. B. Quick ratio. C. Days' sales in average receivables. D. Return on assets.
D. Return on assets.
The management of working capital is concerned with the effective and efficient use of current assets and current liabilities, not with all assets. The return on assets measures the rate of return earned on total assets or total equity and, therefore, is not useful in evaluating just current assets (or current liabilities).
