Purchase Solution

# Inventory turnover and effect on current ratio

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

##### Solution Summary

The solution explains how to calculate inventory turnover and the effect on current ratio of various actions

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

The Inventory days are defined as
Days Inventory=Inventory/(COGS/365)

Assuming 365 days in a year. Rearranging the above equation in terms of COGS gives us
COGS=(Inventory*365)/Days Inventory
=(30000*365)/30
=365,000
This is the annual cost of goods sold
Inventory Turnover Ratio=COGS/Inventory
365,000/30,000
=12.17

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?

It is given that the average collection period (ACP) or the credit period is 60 days. Assuming all annual sales are credit sales, the Average Value of unpaid bills or the Accounts Receivables (AR) are given by
ACP = ...

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