To calculate the Cash Gap, we need to use the following formula:
Cash Gap = Days of Inventory Outstanding + Days of Sales Outstanding - Days of Payables Outstanding
Days of Inventory Outstanding can be calculated as follows:
Days of Inventory Outstanding = (Ending Inventory / Cost of Goods Sold) * 365
Days of Inventory Outstanding = (18000 / 70000) * 365
Days of Inventory Outstanding = 94.29 days
Days of Sales Outstanding can be calculated as follows:
Days of Sales Outstanding = (Accounts Receivable / Net Sales Revenue) * 365
Days of Sales Outstanding = (6500 / 120000) * 365
Days of Sales Outstanding = 19.96 days
Days of Payables Outstanding are given as 40 days.
Therefore, the Cash Gap can be calculated as:
Cash Gap = 94.29 + 19.96 - 40
Cash Gap = 74.25 days
1. Since the Cash Gap is positive, it means that the company needs a source of finance to cover its operating cycle. The company needs facilities to cover 74.25 days.
2. The company can cover the Gap by obtaining a short-term loan or a line of credit from a bank or other financial institution. The company can also negotiate better payment terms with its suppliers or encourage customers to pay more quickly.
3. The point of strength in the company operating cycle is its low Days of Sales Outstanding, which means that it collects payments from customers quickly. The point of weakness is its high Days of Inventory Outstanding, which means that it holds inventory for a relatively long time before selling it. The high Cash Gap also indicates that the company may face cash flow problems if it does not manage its working capital effectively.