Days sales outstanding = Accounts receivable / (Annual credit sales÷365 days) = $56,753 / (727,679÷365 days) = $56,753 / 1,993.64 = 28.47 ≈ 28 days
Days in payables = Accounts payable / (Cost of goods sold÷365 days) = $38,585 / ($466,562÷365 days) = $38,585 / 1,278.25 = 30.19 ≈ 30 days
Cash conversion period = Days in inventory + Days sales outstanding – Days in payables = 70 days + 28 days – 30 days = 68 days.
Based on the computation above, Pearson Air Conditioning & Service will need to finance 68 days of operations with its working capital, which is over two months of operations. This certainly will place the …show more content…
Pearson Air & Conditioning services financed its operations mostly through debt. Its total liabilities (both current and long term) were $136,211 compared to stockholders’ equity of $126,625. The company might be able to reduce its bank loans by reducing its inventory levels, its cash balance, and speeding up the collection of its credit sales. Currently, the company is paying above the prime rate and this could be because of liquidity risk, inflation risk, or even default risk. If the company expands its bank loans, the bank might increase the interest rate thinking that the company is having liquidity problems.
Pearson Air Conditioning & Services is doing a good job managing its accounts payable. It takes 30 days to pay its accounts (see question 5 for calculation), which is not bad. However, the company was not taking advantage of the discounts offered by the suppliers. The company paid 37% for using the supplier’s money every year (see below for calculation). Another thing the company could do to improve its accounts payable is to purchase most of its supplies under the floor plan arrangement. This will help the company save some money since there are no carrying costs.
Percentage Annual interest