Consider the case of Black Sheep Broadcasting Company: Black Sheep Broadcasting
ID: 2614060 • Letter: C
Question
Consider the case of Black Sheep Broadcasting Company: Black Sheep Broadcasting Company is a mature firm that has a stable flow of business. The following data was taken from its financial statements last year: Annual sales Cost of goods sold Inventory Accounts receivable Accounts payable $9,700,000 $6,305,000 $3,100,000 $1,900,000 $2,400,000 Black Sheep Broadcasting's CFO is interested in determining the length of time funds are tied up in working capital. Use the information in the preceding table to complete the following table. (Note: Use 365 days as the length of a year in all calculations, and round all values to two decimal places.) Value Inventory Conversion Period Average collection period Payables Deferral Period Cash conversion cycle Both the inventory conversion period and payables deferral period use the average daily COGS in their denominators, whereas the average collection period uses average daily sales in its denominator. Why do these measures use different inputs? Current assets should be divided by sales, but current liabilities should be divided by the COGS. Inventory and accounts payable are carried at cost on the balance sheet, whereas accounts receivable are recorded at the price at which goods are sold.Explanation / Answer
Inventory conversion period = (Inventory/Cost of goods sold) x 365
= (3,100,000/6,305,000) x 365
= 179.46 days
Average collection period = (Accounts receivable/Annual sales) x 365
= (1,900,000/9,700,000) x 365
= 71.49 days
Payables Deferral period = (Accounts payable/Cost of goods sold) x 365
= (2,400,000/6,305,000) x 365
= 138.94 days
Cash conversion cycle = Inventory conversion period + Average collection period - Payables deferral period
= 179.46 + 71.49 - 138.94
= 112 days
Both the inventory conversion period and payables deferral period use the average daily COGS in their denominators,whereas the average collection period uses average daily sales in its denominator. It happens because inventory and accounts payables are recorded in the books at cost price but accounts receivables are recorded in the books at sale price.
Hence, correct option is (b)
Answer of case in discussion
Correct option is (a)
The CFO is not taking into account the amount of time , the company has to pay its suppliers. Generally, there is a certain length of time,between the purchase of materials and labor and the payment of cash for them. The CFO can reduce the estimated length of bank loan by this amount of time.
Hence, the length of bank loan will be = 40 days to manufacture and sell the product + 35 days to receive payment from customers - Credit period allowed by suppliers of materials and labor.