Week 22 - The Appraisal of Working Capital Pt2

Question 1

What does Inventory Turnover measure?

Answer 1

It measures how many times inventory is sold and replaced during the year.

Question 2

What is the formula for Inventory Turnover?

Answer 2

Inventory Turnover = Cost of Goods Sold (COGS)/ Inventory

Question 3

What does Days Inventory Held (Inventory Holding Period) measure?

Answer 3

It measures the average number of days inventory is held before being sold.

Question 4

What is the formula for Days Inventory Held?

Answer 4

Days Inventory Held = 365/ Inventory Turnover

Question 5

What does a higher inventory turnover generally indicate?

Answer 5

It suggests efficient inventory management and quicker sales.

Question 6

What does a longer inventory holding period suggest?

Answer 6

It may indicate slow-moving inventory or overstocking.

Question 7

What does Inventory Turnover measure?

Answer 7

It measures how many times a company can sell and replace its inventory during the year.

Question 8

What is the formula for Inventory Turnover?

Answer 8

Inventory Turnover = Costs of Goods Sold (COGS)/ Inventory

Question 9

What could a low inventory turnover imply?

Answer 9

Weak sales, or

Excess inventory, possibly in preparation for future demand.

Question 10

What could a high inventory turnover imply?

Answer 10

Strong sales, or

Insufficient inventory, possibly risking stockouts.

Question 11

Inventory turnover
Example: J Sainsbury plc 2020
– COGS in 2020: £26,977m
– Inventory at the year end 2020: £1,732

Answer 11

Inventory turnover = 26977/ 1732 = 15.58 times
Interpretation:
– On average, Sainsbury can sell and replace the inventory 16 times in a year

Question 12

What does the Inventory Holding Period indicate?

Answer 12

It shows the average number of days a company holds inventory before selling it.

Question 13

What is the formula for Inventory Holding Period?

Answer 13

Inventory Holding Period = Inventory/ Costs of Goods Sold x 365 days

Question 14

Why is a longer inventory holding period significant?

Answer 14

It means cash is tied up longer in inventory, reducing liquidity.

Question 15

What could an abnormally high inventory holding period indicate?

Answer 15

Poor sales, or

Bulk purchasing leading to excess stock.

Question 16

Inventory holding period
Example: J Sainsbury plc 2020
– COGS in 2020: £26,977m
– Inventory at the year end 2020: £1,732

Answer 16

Inventory Holding Period = 1732/ 26977 x365 = 23.43 days

Interpretation:
– Sainsbury needs to hold inventory on average 23 days before the inventory are sold.

Question 17

Why might you use average inventory instead of year-end inventory?

Answer 17

To get a more representative figure of inventory levels throughout the year and smooth out fluctuations.

Question 18

How is average inventory calculated?

Answer 18

Average Inventory = (Inventory at the year end + Inventory at the previous year end) / 2

Question 19

When should you use average inventory instead of year-end inventory?

Answer 19

When combining balance sheet and income statement data, especially for ratios like inventory turnover or inventory holding period.

Question 20

What does the Inventory Holding Period tell us?

Answer 20

It tells us how long the company typically takes to sell its inventory.

Question 21

Is a lower inventory holding period generally better?

Answer 21

Yes, it usually means the company sells inventory quickly, improving cash flow and efficiency.

Question 22

What is the Operating Cycle?

Answer 22

The time from purchasing inventory to collecting cash from customers.

Question 23

What is the Operating Cash Cycle (Cash Conversion Cycle)?

Answer 23

The time between paying suppliers and receiving payment from customers.

Question 24

What is the formula for the Operating Cash Cycle?

Answer 24

OperatingCashCycle= InventoryHoldingPeriod + ReceivablesSettlementPeriod − PayablesPaymentPeriod

Question 25

What does a shorter Operating Cash Cycle indicate?

Answer 25

Better liquidity management, as the company gets cash faster after paying suppliers.

Question 26

What does a longer Operating Cash Cycle indicate?

Answer 26

Cash is tied up longer in operations, possibly increasing the need for short-term financing.

Question 27

What does Y represent in the operating cash cycle?

Answer 27

Inventory Holding Period – the time between buying inventory and selling goods.

Question 28

What does Z represent in the operating cash cycle?

Answer 28

Receivables Settlement Period – the time between selling goods and receiving cash.

Question 29

What does X represent in the operating cash cycle?

Answer 29

Payables Payment Period – the time between purchasing inventory and paying suppliers.

Question 30

What is the formula for the Entire Operating Cycle?

Answer 30

Entire Operating Cycle= Y + Z = Inventory Holding Period + Receivables Settlement Period

Question 31

What is the Entire operating cycle (Y + Z)?

Answer 31

The period from buying goods (inventories) to collecting sales generated cash

Question 32

What is the Operating cash cycle: Y + Z – X?

Answer 32

The period from paying for goods (inventories) to collecting sales generated cash

Question 33

What is the formula for the Operating Cash Cycle?

Answer 33

Operating Cash Cycle = Y + Z − X = Inventory Holding Period + Receivables Settlement Period − Payables Payment Period

Question 34

Why is a short operating cash cycle desirable?

Answer 34

It means the company recovers cash more quickly, improving liquidity and reducing reliance on short-term financing.

Question 35

What does a positive Operating Cash Cycle (OCC) mean?

Answer 35

The company collects cash from customers after (slower than) paying suppliers

Question 36

What are the implications of a positive OCC?

Answer 36

Cash is tied up in operations The company may need short-term financing to bridge the gap It can cause liquidity pressure

Question 37

What does a negative OCC indicate?

Answer 37

The company collects cash from customers before (faster than) paying suppliers

Question 38

What should companies aim for with OCC?

Answer 38

A shorter or even negative OCC, to reduce reliance on external financing and improve liquidity.

Question 39

What does the Operating Cash Cycle (OCC) measure?

Answer 39

It measures how long it takes for a company to convert its investments in inventory and other resources into cash flows from sales (also called the Cash Conversion Cycle)

Question 40

Why is the Operating Cash Cycle also called the Cash Conversion Cycle?

Answer 40

Because it helps assess how efficiently a company converts its resources into cash.

Question 41

What does a shorter Operating Cash Cycle indicate?

Answer 41

It means the company manages its working capital more efficiently, improving liquidity and reducing the need for external financing.

Question 42

What does a negative Operating Cash Cycle (OCC) indicate?

Answer 42

It means the company receives payments from customers before paying suppliers, indicating strong working capital efficiency.

Question 43

Which types of businesses are likely to have a negative Operating Cash Cycle?

Answer 43

Retail businesses with high inventory turnover often experience a negative OCC.

Question 44

What is the key goal of managing the Operating Cash Cycle?

Answer 44

To minimise the length of the operating cash cycle, thereby improving working capital efficiency.

Question 45

Why is the Operating Cash Cycle (OCC) considered a liquidity metric?

Answer 45

It helps assess how efficiently a company manages its working capital by measuring how quickly it can convert its inventory and receivables into cash.

Question 46

The Operating Cash Cycle Example: J Sainsbury plc 2020 – Inventory Holding Period: 23.43 days – Settlement Period for Receivables: 10.21 days – Payment Period for Payables: 58.27 days

Answer 46

Operating cash cycle: = Inventory holding periods + Settlement periods for receivables - Payment period for payables = 23.43 days + 10.21 days – 58.27 days = – 24.63 days Interpretation – Sainsbury has a negative number of operating cash cycle, it means the cash for its working capital is not tied up for long, and the liquidity is great

Question 47

What does the Operating Cash Cycle tell us?

Answer 47

It tells us how long the company needs to wait between paying its suppliers and receiving cash from its customers.

Question 48

Why is a lower Operating Cash Cycle (OCC) generally preferable?

Answer 48

A lower OCC means the company is converting inventory into cash faster, which improves liquidity and reduces the need for external financing.

Question 49

What does a negative Operating Cash Cycle indicate?

Answer 49

It means the company collects cash from customers faster than it takes to sell inventory and pay suppliers, indicating very efficient working capital management.

Question 50

Can any companies have a negative cash cycle?

Answer 50

Yes, typically businesses with high inventory turnover and quick receivables collection, such as retailers, can have a negative cash cycle.