AAA Dog 'n Cat Shop sells a variety of merchandise for the pet owner, including pet food, grooming supplies, toys, and kennels. Most customers use the option to purchase on account and take 60 days, on average, to pay their accounts. The owner of AAA Dog 'n Cat Shop, Adam Fleming, has decided the company needs a bank loan because the accounts payable need to be paid in 30 days. Adam estimates that it takes 45 days, on average, to sell merchandise from the time it arrives at his store. Since the company earns a good profit every year, the bank manager is willing to give AAA Dog 'n Cat Shop a loan but wants monthly financial statements.
Adam has also noticed that, while some of the merchandise sells very quickly, other items do not. Sometimes he wonders just how long he has had some of those older items. He has also noticed that he regularly seems to run out of some merchandise items. Adam is also concerned about preparing monthly financial statements. The company uses a periodic inventory system and Adam counts inventory once a year. He is wondering how he is going to calculate the cost of goods sold for the month without counting the inventory at the end of every month. He has come to you for help.
Instructions
(a) Explain to Adam what an operating cycle is and why he is having problems paying the bills.
(b) Explain to Adam how the periodic inventory system is contributing to his problems.
Taking It Further
Make a recommendation about what inventory system the company should use and why.