Case 3: BOP Clothing Co.

As discussed in the chapter, an important consideration in evaluating current liabilities is a companys operating cycle. The operating cycle is the average time required to go from cash to cash in generating revenue. To determine the length of the operating cycle, analysts use two measures: the average days to sell inventory (inventory days) and the average days to collect receivables (receivable days). The inventory-days computation measures the average number of days it takes to move an item from raw materials or purchase to final sale (from the day it comes in the companys door to the point it is converted to cash or an account receivable). The receivable-days computation measures the average number of days it takes to collect an account.

Most businesses must then determine how to finance the period of time when the liquid assets are tied up in inventory and accounts receivable. To determine how much to finance, companies first determine accounts payable dayshow long it takes to pay creditors. Accounts payable days measures the number of days it takes to pay a supplier invoice. Consider the following operating cycle worksheet for BOP Clothing Co.

	2019		2020
Cash	$45,000		$30,000
Accounts receivable	250,000		325,000
Inventory	830,000		800,000
Accounts payable	720,000		775,000
Purchases	1,100,000		1,425,000
Cost of goods sold	1,145,000		1,455,000
Sales	1,750,000		1,950,000
Operating Cycle
Inventory days1	264.6	200.7
Receivable days2	52.1	60.8
Operating cycle	316.7	261.5
Less: Accounts payable days3	238.9	198.5
Days to be financed	77.8	63.0
Working capital	$405,000	$380,000
Current ratio	1.56	1.49
Acid-test ratio	0.41	0.46
1Inventory days = (Inventory 365) Cost of goods sold
2Receivable days = (Accounts receivable 365) Sales
3Accounts payable days = (Accounts payable 365) Purchases
Purchases = Cost of goods sold + Ending inventory Beginning inventory. The ratios above assume that other current assets and liabilities are negligible.

These data indicate that BOP has reduced its overall operating cycle (to 261.5 days) as well as the number of days to be financed with sources of funds other than accounts payable (from 78 to 63 days). Most businesses cannot finance the operating cycle with accounts payable financing alone, so working capital financing, usually short-term interest-bearing loans, is needed to cover the shortfall. In this case, BOP would need to borrow less money to finance its operating cycle in 2020 than in 2019.

Instructions

a. Use the BOP analysis to briefly discuss how the operating cycle data relate to the amount of working capital and the current and acid-test ratios.

b. Select two competing public companies for analysis, such as: Ford and GM, WalMart and Target.

c. Use data analytics to analyze the liquidity of the two companies. As noted in your readings, that would include at minimum an analysis of the current ratio, current liability balances arising from accounts payable, and the use of short-term financing. If you find additional data analytics being used by accountants and financial analysts, then report how they work.