Question

A Corp. had total sales of $1,000,000 in 2018 (80 % of its sales are credit). The company's gross profit margin is 20%, its ending inventory is $100,000, and its accounts receivable balance is $60,000. What additional amount of cash could the firm have generated if it had increased its inventory turnover ratio to 10.0 and reduced its average collection period to 22.375 days. With the same level of sales?

Answer 1

Current Scenario:

Credit Sales = 80% * Total Sales
Credit Sales = 80% * $1,000,000
Credit Sales = $800,000

Gross Profit = 20% * Total Sales
Gross Profit = 20% * $1,000,000
Gross Profit = $200,000

Gross Profit Margin = Total Sales - Cost of Goods Sold
$200,000 = $1,000,000 - Cost of Goods Sold
Cost of Goods Sold = $800,000

New Scenario:

Inventory Turnover = Cost of Goods Sold / Inventory
10.00 = $800,000 / Inventory
Inventory = $80,000

Average Collection Period = 365 * Accounts Receivable / Credit Sales
22.375 = 365 * Accounts Receivable / $800,000
Accounts Receivable = $49,041.10

Additional Cash Generated = Change in Inventory + Change in Accounts Receivable
Additional Cash Generated = ($100,000 - $80,000) + ($60,000 - $49,041.10)
Additional Cash Generated = $30,958.90