Suppose that Sam Industries has annual sales of $2 million, cost of goods sold of $950,000, average inventories of $45,000, and average accounts receivable of $90,000. Assuming that all of Sam's sales are on credit, what will be the firm's operating cycle?

34 days

Explanation:

Formula

The Operating Cycle formula is as follows:  

Operating Cycle  =  Inventory Period + Accounts Receivable Period

Inventory Period  =  365 / Inventory Turnover

Where the formula for Inventory Turnover is:  

Inventory Turnover  =  Cost of Goods Sold / Average Inventory

The Accounts Receivable Period is calculated as follows:

Accounts Receivable Period  =  365 / Receivables Turnover  

Where the formula for Receivables Turnover is:

Receivables Turnover = Credit Sales / Average Accounts Receivable

Therefore, the detailed formula for Operating Cycle is:  

365 / (Cost of Goods Sold / Average Inventory) + 365 /(Credit Sales / Average Accounts Receivable)

Operating Cycle = [365 / (950,000/45,000) + 365 / (2,000,000/90,000)]

Operating Cycle = 17.3 + 16.43 which 33.73 days approximately 34 days

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