What is an Operating Cycle in a business? Why does a business need Working Capital? Previous Next. View Larger Image. Operating Cycle In Business. The following are all factors that influence the duration of the operating cycle and cash cycle: The payment terms extended to the company by its suppliers. Longer payment terms shorten the operating cycle since the company can delay paying out cash.
The order fulfillment policy. Since a higher assumed initial fulfillment rate increases the amount of inventory on hand, which increases the operating cycle. The credit policy and related payment terms.
Once those reductions are recorded at the end of a period, net sales are calculated. Net sales see Figure equals gross sales less sales discounts, sales returns, and sales allowances. Recording the sale as it occurs allows the company to align with the revenue recognition principle. The revenue recognition principle requires companies to record revenue when it is earned, and revenue is earned when a product or service has been provided.
The second accounting entry that is made during a sale describes the cost of sales. The decrease to Merchandise Inventory reflects the reduction in the inventory account value due to the sold merchandise. The increase to COGS represents the expense associated with the sale. The cost of goods sold COGS is an expense account that houses all costs associated with getting the product ready for sale.
This could include purchase costs, shipping, taxes, insurance, stocking fees, and overhead related to preparing the product for sale. By recording the cost of sale when the sale occurs, the company aligns with the matching principle. The matching principle requires companies to match revenues generated with related expenses in the period in which they are incurred. If the baseball league elects to pay with cash, the shoe store would debit Cash as part of the sales entry.
If the baseball league decides to use a line of credit extended by the shoe store, the shoe store would debit Accounts Receivable as part of the sales entry instead of Cash. You may have noticed that sales tax has not been discussed as part of the sales entry. Sales taxes are liabilities that require a portion of every sales dollar be remitted to a government entity.
This would reduce the amount of cash the company keeps after the sale. Sales tax is relevant to consumer sales and is discussed in detail in Current Liabilities. There are a few transactional situations that may occur after a sale is made that have an effect on reported sales at the end of a period. Sales discounts are incentives given to customers to entice them to pay off their accounts early. Why would a retailer offer this?
The discount serves several purposes that are similar to the rationale manufacturers consider when offering discounts to retailers. It can help solidify a long-term relationship with the customer, encourage the customer to purchase more, and decreases the time it takes for the company to see a liquid asset cash. Cash can be used for other purposes immediately such as reinvesting in the business, paying down loans quicker, and distributing dividends to shareholders.
This can help grow the business at a more rapid rate. Otherwise, they have 30 days to pay in full but do not receive a discount. If the customer does not pay within the discount window, but pays within 30 days, the retailing company records a credit to Accounts Receivable, and a debit to Cash for the full amount stated on the invoice.
If the customer is able to pay the account within the discount window, the company records a credit to Accounts Receivable, a debit to Cash, and a debit to Sales Discounts. The sales discounts account is a contra revenue account that is deducted from gross sales at the end of a period in the calculation of net sales.
Sales Discounts has a normal debit balance, which offsets Sales that has a normal credit balance. The retailer recorded the following entry for the initial sale. The journal entry to record the sale of the inventory follows the entry for the sale to the customer. Now, assume that the customer paid the retailer within the day period but did not qualify for the discount. The following entry reflects the payment without the discount.
Should employees or companies provide discounts to employees of other organizations? While many companies offer their employees discounts as a benefit, some companies also offer discounts or free products to non-employees who work for governmental organizations.
The long-term benefits of discounts are contrasted with organizational codes of ethics and conduct that limit others from accepting discounts from your organization. Providing discounts may create ethical dilemmas. In doing so, they should consider the following criteria on gifts, hospitality and other benefits, bearing in mind the full context of this Code. Public servants shall not accept or solicit any gifts, hospitality or other benefits that may have a real or apparent influence on their objectivity in carrying out their official duties or that may place them under obligation to the donor.
At issue is that the employee of the outside organization is placed in a conflict between their personal interests and the interest of their employer. The professional accountant should always be aware of the discount policy of any outside company prior to providing discounts to the employees of other companies or organizations.
If a customer purchases merchandise and is dissatisfied with their purchase, they may receive a refund or a partial refund, depending on the situation. When the customer returns merchandise and receives a full refund, it is considered a sales return. When the customer keeps the defective merchandise and is given a partial refund, it is considered a sales allowance.
The biggest difference is that a customer returns merchandise in a sales return and keeps the merchandise in a sales allowance. When a customer returns the merchandise, a retailer issues a credit memo to acknowledge the change in contract and reduction to Accounts Receivable, if applicable.
The retailer records an entry acknowledging the return by reducing either Cash or Accounts Receivable and increasing Sales Returns and Allowances. Cash would decrease if the customer had already paid for the merchandise and cash was thus refunded to the customer.
Accounts Receivable would decrease if the customer had not yet paid on their account. Like Sales Discounts, the sales returns and allowances account is a contra revenue account with a normal debit balance that reduces the gross sales figure at the end of the period.
If so, the company would record a decrease to Cost of Goods Sold COGS and an increase to Merchandise Inventory to return the merchandise back to the inventory for resale.
If the merchandise is in sellable condition but will not realize the original cost of the good, the company must estimate the loss at this time. On the other hand, when the merchandise is returned and is not in sellable condition, the retailer must estimate the value of the merchandise in its current condition and record a loss. This would increase Merchandise Inventory for the assessed value of the merchandise in its current state, decrease COGS for the original expense amount associated with the sale, and increase Loss on Defective Merchandise for the unsellable merchandise lost value.
The first entry reflects the initial sale by the nursery. The second entry reflects the cost of goods sold. Upon receipt, the customer discovers the plants have been infested with bugs and they send all the plants back. The nursery would record the following entry for sales allowance associated with plants. The nursery would also record a corresponding entry for the inventory and the cost of goods sold for the returned plants.
For both the return and the allowance, if the customer had already paid their account in full, Cash would be affected rather than Accounts Receivable. There are differing opinions as to whether sales returns and allowances should be in separate accounts.
Separating the accounts would help a retailer distinguish between items that are returned and those that the customer kept. This can better identify quality control issues, track whether a customer was satisfied with their purchase, and report how many resources are spent on processing returns.
You may have noticed our discussion of credit sales did not include third-party credit card transactions. This is when a customer pays with a credit or debit card from a third-party, such as Visa , MasterCard , Discover , or American Express. These entries and discussion are covered in more advanced accounting courses. A more comprehensive example of merchandising purchase and sale transactions occurs in Calculate Activity-Based Product Costs and Compare and Contrast Traditional and Activity-Based Costing Systems , applying the perpetual inventory method.
Major retailers must find new ways to manage inventory and reduce operating cycles to stay competitive. Companies such as Amazon. Check out Stock Analysis on Net to find out how they do this and to see a comparison of operating cycles for top retail brands.
Figure Which of the following is an example of a contra revenue account? Figure If a customer purchases merchandise on credit and returns the defective merchandise before payment, what accounts would recognize this transaction? Figure What are some benefits to a retailer for offering a discount to a customer?
It helps solidify a long-term relationship with the customer, encourages the customer to purchase more, and decreases the time it takes for the company to see a liquid asset cash. Cash can be used for other purposes immediately, such as reinvesting the business, paying down loans quicker, and distributing dividends to shareholders. Figure What is the difference between a sales return and a sales allowance?
A sales return occurs when a customer returns merchandise for a full refund. A sales allowance occurs when a customer keeps the merchandise and is issued a partial refund.
What would the retailer pay in cash if they received the discount? Create the journal entries for Bates to recognize the following transactions. Figure Marx Corp. Marx Corp pays in full for the fax machines on April Create the journal entries for Marx Corp. Figure Match each of the following terms with the best corresponding definition. Conversely, a business may have fat margins and yet still require additional financing to grow at even a modest pace, if its operating cycle is unusually long.
If a company is a reseller, then the operating cycle does not include any time for production - it is simply the date from the initial cash outlay to the date of cash receipt from the customer. The following are all factors that influence the duration of the operating cycle:. The payment terms extended to the company by its suppliers. Longer payment terms shorten the operating cycle, since the company can delay paying out cash.
The order fulfillment policy, since a higher assumed initial fulfillment rate increases the amount of inventory on hand, which increases the operating cycle. The credit policy and related payment terms, since looser credit equates to a longer interval before customers pay, which extends the operating cycle.
Thus, several management decisions or negotiated issues with business partners can impact the operating cycle of a business.
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