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Q: Finance ( Answered 4 out of 5 stars,   1 Comment )
Subject: Finance
Category: Business and Money
Asked by: mrynot-ga
List Price: $10.00
Posted: 01 Feb 2005 15:50 PST
Expires: 03 Mar 2005 15:50 PST
Question ID: 467229
Hello. I need some guidance preparing for finance exam. The following
are some of the questions that I am getting stumped on. Please answer
and advise. Thank you for your help.

1. Afirm has $30,000 of inventory. If this represents 30 days? sales,
what is the annual cost of goods sold? What is the inventory turnover

2.  On average, it takes Microlimp?s customers 60 days to pay their
bills. If Microlimp has
annual sales of $500 million, what is the average value of unpaid bills?

3.  How would the following actions affect a firm?s current ratio?
    a. Inventory is sold.
    b. The firm takes out a bank loan to pay its suppliers.
    c. A customer pays its overdue bills.
    d. The firm uses cash to purchase additional inventories.

4. If a firm pays its bills with a 30-day delay, what fraction of its
purchases will be paid in the current quarter? In the following
quarter? What if the delay is 60 days?
Subject: Re: Finance
Answered By: omnivorous-ga on 02 Feb 2005 11:32 PST
Rated:4 out of 5 stars
Mrynot ?

There actually is enough information to answer these questions, if we
make several assumptions.  Be very careful about the assumptions ?
checking with your finance prof to make sure that they?re not wrong:

Assumption #1:

Inventory turnover is defined as: Cost of Goods Sold / Average Inventory

IT IS NOT normally defined this way, which is why Siliconsamurai has
made the comment that he has.  It?s normally defined as Sales /
Inventory ? and that?s how you?ll see Wall Street analysts define the
term in financial analyses:

?Inventory Turnover?

Assumption #2: 

A 360-day year.  Except for lending purposes (when all 365 days are
important in interest calculations), it?s like assuming a 30-day month
? not true but close enough for comparative analysis.

Okay, now let?s get on to the answers:

1.	Annual COGS = 12 x $30K = $360,000
Inventory turnover =  ($360K/$30K) = 12

2.	(60 days / 360 days) x $500M = $83.3 million of ARO or average
receivables outstanding.  Note that 60 days worth of receivables is
extremely long in the real world.

3.	Okay, first let?s define Current Ratio: Current Assets / Current Liabilities 

Current Assets = cash + accounts receivable + inventory + marketable
securities + prepaid expenses

Current Liabilities = current portions of [interest + accounts payable
+ short-term loans due + expenses incurred but unpaid + other debts
(e.g., leases)]

A.	Inventory is sold.  If sold at a profit of say 30%, inventory
decreases by x and Accounts Receivable go up by 1.43x ? so the Current
Ratio increases.

Note: if sold at a LOSS, the Current Ratio decreases.

B.	Again more assumptions: we?ll take the bank loan now ? but the
suppliers aren?t paid yet.  And, no interest is due ? we set the loan
up for semi-annual payments.

Answer: no change in Current Ratio.  When the suppliers are paid,
accounts payable goes down and the Current Ratio increases.

C.	This also is a tough one: how overdue is the customer?  It?s
routine to have customers who are 30 days overdue ? but past 90 days
they?d go into a bad debt allowance.  In the Current Assets, ?Accounts
Receivable? are defined as AR minus the bad debt allowance.

I might recommend as an excellent resource for finance issues and definitions, 
the Merrill Lynch publication, ?How to Read a Financial Report,? first
published in 1973, because it?s both more complete than simple sources
like and yet succinct on these issues.  I?ve been
through 3 copies in 30 years of business work and continually refer to

The online file (5.1M) is available here as an Acrobat (PDF) file and
you?ll want to see the Current Assets section:
Merrill Lynch

Okay, now the answer: if overdue but not in the bad debt reserve: AR
goes to cash and NO CHANGE in Current Ratio.

If they were written off as a bad debt ? it?s "found" money.  It?s not
in AR any more and ?magically? adds to Cash without a change in AR. 
However, there?s an impact on net profits because you?ll be reversing
a former write-off -- but that has nothing to do with the Current
Ratio (sometimes called a "Quick Ratio").

D.	Cash goes down, inventories go up ? at the same value.  No change
in Currrent Ratio.

4.	Here the assumption on growth is important.  We?ll assume level
sales because the percentages decrease if sales are increasing; and
increase if sales are falling.

A 30-day delay means that we?re paying 30 days of last quarter plus 60
days of this quarter.  So we?re paying 90 days DURING the quarter ?
two-thirds of it for current buys and one-third for last quarter?s

The answer?s the same with a 60-day delay ? we?re still paying 90 days
of receivables.  However, in this case we?re paying 60 days from last
quarter and only 1/3 from the current period.


Inasmuch as some of this may be confusing, don?t hesitate to ask for a
clarification before rating this Google Answer.

Best regards,

mrynot-ga rated this answer:4 out of 5 stars
Thank you, this is extremely helpful.

Subject: Re: Finance
From: siliconsamurai-ga on 02 Feb 2005 10:30 PST
just looking at #1, there isn't enough information given to provide an
answer other than an essay.

What do you mean $30K inventory, is that the cost? does that include
all the costs involved of carrying and managing the inventory also? if
it is the cost for one month then the annual cost is just 12*$30K so I
can't believe that is the actual question.

2 the average value as you state it appears to be 1/6 of the annual
sales so again I don't think you have posed the question accurately.

Or, am I missing something?

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