Question 26.Q4: (a) Calculate the operating cycle for Moribund for 20X2 on t...
(a) Calculate the operating cycle for Moribund for 20X2 on the basis of the following information.
Tip. You will need to calculate inventory turnover periods (total year end inventory over cost of goods sold), receivables as daily sales, and payables in relation to purchases, all converted into ‘days’.
(b) List the steps which might be taken in order to improve the operating cycle.
| $ | |
| Inventory: raw materials | 150,000 |
| work in progress | 60,000 |
| finished goods | 200,000 |
| Purchases | 500,000 |
| Trade accounts receivable | 230,000 |
| Trade accounts payable | 120,000 |
| Sales | 900,000 |
| Cost of goods sold | 750,000 |
(a) The operating cycle can be found as follows.
Inventory turnover period: \frac{\text{Total closing inventory × 365}}{\text{Cost of goods sold}}
plus
Accounts receivable collection period: \frac{\text{Closing trade receivables × 365 }}{\text{Sales}}
less
Accounts payable payment period: \frac{\text{Closing trade payables × 365 }}{\text{Purchases}}
(b) The steps that could be taken to reduce the operating cycle include the following.
(i) Reducing the average raw material inventory turnover
(ii) Reducing the time taken to produce goods. However, the company must ensure that quality is not sacrificed as a result of speeding up the production process.
(iii) Increasing the period of credit taken from suppliers. The credit period seems very long – the company is allowed three months credit by its suppliers, and probably could not be increased. If the credit period is extended then the company may lose discounts for prompt payment.
(iv) Reducing the average finished goods inventory turnover.
(v) Reducing the average receivables collection period. The administrative costs of speeding up debt collection and the effect on sales of reducing the credit period allowed must be evaluated. However, the credit period does seem very long by the standards of most industries. It may be that generous terms have been allowed to secure large contracts and little will be able to be done about this in the short term.
| 20X2 | |
| Total closing inventory ($) | 410,000 |
| Cost of goods sold ($) | 750,000 |
| Inventory turnover period | 199.5 days |
| Closing receivables ($) | 230,000 |
| Sales ($) | 900,000 |
| Receivables collection period | 93.3 days |
| Closing payables ($) | 120,000 |
| Purchases ($) | 500,000 |
| Payables payment period | (87.6 days) |
| Length of operating cycle (199.5 + 93.3 – 87.6) | 205.2 days |