Pretty Lady Cosmetic Products has an average production process time of 40 days.

Question

Pretty Lady Cosmetic Products has an average production process time of 40 days. Finished goods are kept on hand for an average of 15 days before they are sold. Accounts receivable are outstanding an average of 35 days, and the firm receives 40 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 3 accounts?

Explanation / Answer

cash conversion cycle CCC = DIO + DSO - DPO

ie CCC = 15+35-40 = 10 days

Operating cycle CC starts from the day the firm rx raw material for production till realization of sales. So OC = 40+15+35-40 = 50 days.....Ans (A)

Annual Sales = $1200,000

COGS = $900,000

Days Inventory Outstanding (DIO): This addresses the question of how many days it takes to sell the entire inventory. The smaller this number is, the better.

DIO = Average inventory/COGS per day = Average inventory/($900,000/365) = 15days

So Average inventory = $36,986.30

Days Sales Outstanding (DSO): This looks at the number of days needed to collect on sales and involves AR. While cash-only sales have a DSO of zero, people do use credit extended by the company, so this number is going to be positive. Again, smaller

is better.

DSO = Average AR / Revenue per day = Average AR/($1200,000/365) =35 days

So Average AR = $115,068.50

Days Payable Outstanding (DPO): This involves the company's payment of its own bills or AP. If this can be maximized, the company holds onto cash longer, maximizing its investment potential; therefore, a longer DPO is better.

DPO = Average AP / COGS per day = Average AP/($900,000/365) =40 days

So Average AP = $98,630.14

So net financing needs = Avge Inv + Avge A/R - Avge A/P = 36986.30+115068.50-98630.14 = $53,424.66

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