Pretty Lady Cosmetic Products Has An Average Production Proc

Pretty Lady Cosmetic Products Has An Average Production Process Ti

Pretty Lady Cosmetic Products has an average production process time of forty days. Finished goods are kept on hand for an average of fifteen days before they are sold. Accounts receivable are outstanding an average of thirty-five days, and the firm receives forty 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 three accounts?

Paper For Above instruction

The assessment of a company's short-term operating cycle is critical for understanding its liquidity and working capital management. The operating cycle encompasses the time taken from purchasing raw materials to collecting cash from sales. To estimate this cycle for Pretty Lady Cosmetic Products, we need to analyze the various components: production time, inventory holding period, receivable period, and payable period.

Part A: Estimation of the Cash Operating Cycle

The average production process time is forty days, which reflects the period needed to manufacture the products. Once finished, inventory is held for an additional fifteen days before sale, making the total inventory period 15 days. Accounts receivable are outstanding for an average of thirty-five days, representing the collection period from customers. The accounts payable period, or the credit period obtained from suppliers, is forty days, which delays cash outflows.

The operating cycle is calculated as:

• Operating Cycle = Inventory Period + Receivables Collection Period
• Operating Cycle = 15 days + 35 days = 50 days

To determine how frequently the cycle turns over annually, we divide the total days in a year by the operating cycle length:

Number of cycles per year = 365 days / 50 days ≈ 7.3 cycles

This indicates that Pretty Lady Cosmetic Products completes approximately seven full operating cycles each year, which is typical in the cosmetics industry where rapid inventory turnover is common due to product trends and perishability.

Part B: Investment in Accounts Receivable, Inventory, and Accounts Payable

Given net sales of $1,200,000 and cost of goods sold (COGS) of $900,000, we can estimate average balances in receivables, inventory, and payables based on their respective turnover ratios.

1. Accounts Receivable

The receivables turnover ratio is calculated as:

Receivables Turnover = Net Sales / Average Accounts Receivable

→ Average Accounts Receivable = Net Sales / Receivables Turnover

Assuming the collection period aligns with the receivable days of 35 within the cycle, the receivables turnover is:

Receivables Turnover = 365 / 35 ≈ 10.43

Therefore, the average accounts receivable is:

Accounts Receivable = $1,200,000 / 10.43 ≈ $115,000

2. Inventory

The inventory turnover ratio is:

Inventory Turnover = COGS / Average Inventory

Assuming inventory is held for 15 days, the inventory turnover ratio is:

Inventory Turnover = 365 / 15 ≈ 24.33

Average Inventory = COGS / Inventory Turnover = $900,000 / 24.33 ≈ $37,000

3. Accounts Payable

The payables turnover ratio based on the 40-day credit period is:

Payables Turnover = 365 / 40 ≈ 9.13

Average Accounts Payable can thus be estimated as:

Accounts Payable = COGS / Payables Turnover = $900,000 / 9.13 ≈ $98,500

Net Working Capital Requirement

To determine the net financing need, which reflects the capital tied-up in receivables and inventories minus payables, we perform:

Net Working Capital = Accounts Receivable + Inventory - Accounts Payable

Net Working Capital = $115,000 + $37,000 - $98,500 = $53,500

This figure indicates the short-term financing the company would need to support its ongoing operations based on these working capital components.

Additional Considerations

Understanding the cash flow cycle helps management optimize financing strategies. Effective management aims to minimize the net working capital requirement without impairing operational efficiency. Shortening receivable and inventory days or negotiating longer payables can significantly improve cash flow.

Conclusion

Pretty Lady Cosmetic Products' operating cycle is approximately 50 days, with the cycle turning over roughly seven times annually. The company's average working capital investment in receivables and inventory is about $152,000, with payables reducing the net need to approximately $54,000. These insights are valuable for effective liquidity management, particularly in the highly competitive cosmetics industry where cash flow management directly impacts profitability and growth.

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