Question

Use the following information to answer questions 13 to 16.

13.

You are a consultant for Paschke Consulting Services. Your client, the CEO of Nordstrom Inc., has provided the following information about the firm: Sales of $15.86 billion with costs of goods sold equal to $10.16 billion. The average inventory is $2.01 billion, accounts receivable average is $0.15 billion, and payable average is $1.44 billion. Assume a 365 day year and that the average operating cycle and cash cycle of its rivals is 70 days and 20 days, respectively.

You are asked to calculate the operating cycle and cash cycle for the firm.

14. Explain (in words) the operating cycle and cash cycle. What does a longer operating cycle and cash cycle mean?

15. Is your opinion is Nordstrom Inc. doing better or worse than its rivals. As a consultant what specific changes would you recommend to be made to the policies for the management of inventory, receivables, and payables?

16. What will the implementations of the recommendations in (c) do to your Current Ratio and Asset Turnover Ratio?

Answer 1

Inventory Period = Avg Inventory / COGS * 365

= $ 2.01 bn / $ 10.16 bn * 365

= 72.20 days

Accounts Receivable Period = Receivables/ Sales * 365

= $ 0.15 bn / $ 15.86 bn * 365

= 3.45 days

Accounts Payable Period = Trade payables/ COGS * 365

= $ 1.44 bn / $ 10.16 * 365

= 51.73 days

Operating cycle = Inventory period + Accounts receivable period

= 72.20 days + 3.45 days

= 75.65 days ~ 76 days

Cash conversion cycle = Inventory period + Accounts receivable period - Trade payables period

= 75.65 days - 51.73 days

= 23.92 days ~ 24 days

Operating cycle is defined as time taken to produce the goods, sell them and receive payment from customers.

Cash cycle is the length of time taken by company to convert its inventory and related items into cash flow.

Nordstorm is having a higher operating and cash conversion cycle at 76 days and 24 days against its competitors and strive to reduce the cycle in line with industry standards. Longer cycle will tie up its cash and stretch the working capital, resulting in lower growth prospects.