McKinny Enterprises must raise $580,000 to pay off a bank loan at the end of the year. The firm expects sales of $5,200,000 for the year. Depreciation for the year is $315,000. The company's net profit margin is 5%. Can the company pay off its loan through the retention of earnings?
Answer: Net profit = sales × net profit margin = $5,200,000 × .05 = $260,000
Internal funds generated by the firm = net profit + depreciation = $260,000 + $315,000 = $575,000
McKinny cannot pay off its loan by using only internally generated funds.
S.M., Inc. had total sales of $400,000 in 2014 (70 percent of its sales are credit). The company's gross profit margin is 10%, its ending inventory is $80,000, and its accounts receivable is $25,000. What amount of funds can be generated by the company if it increases its inventory turnover ratio to 10.0 and reduces its average collection period to 20 days?
Answer: Average collection period = (accounts receivable)/(annual credit sales/360 days)
20 days = (accounts receivable)/[(400,000)(.70)/360 days]
Accounts receivable = (20 × $280,000)/(360) = $15,556
Funds generated by reducing accounts receivable = $25,000 - $15,556 = $9,444
Inventory turnover = (cost of goods sold)/(ending inventory)
10.0 = [($400,000)(1 - .10)]/(ending inventory)
Ending inventory = ($360,000)/(10.0) = $36,000
Funds generated by reducing inventory = $80,000 - $36,000 = $44,000
Total funds generated = $9,444 + $44,000 = $53,444
