BUS 600 Forum Case Study Analysis posted by Jerry

Forum Case Study Analysis
A Question Regarding Cash Flow Posted by Jerry on Thursday, 1 April 2010, 04:53 PM

When I read The Ten Day MBA chapter 5 about cash flow example, page 169, I don't understand what is the real cost of $10k in inventory and Increased payable of $8000, I understand extra inventory cost money, but is that one part of "cost of goods sold"? Also the "payable" seems just the money owe to farmers and container company, but later Quaker Oats still need to fullfil the payable, so I don't understand why the "inventory" and "payable" in the cash flow calculation.
Could anybody give me some help?

Thanks
Jerry

My respond to Jerry as per below:

Hi Jerry,

Below explanation is based on what I learnt from online research of your questions. Please forgive me if i misintepret, as I have no accounting background or experience.

1. You highlighted that you “don’t understand what is the real cost of $10k in inventory”
1. The case study is about Quaker Oats interest on investment project. They wanted to expand/ increase their production capability by investing in a new machine/ tools (cereal filling machine):
1. This means besides spending $100k on the machine in Year 0, they need to spend additional $10k on buying more raw material to enable the increase of production at the beginning of the investment Year 0 – in this case, the grains or wheat is the raw material.
2. Of course, they have COGS that incurred yearly even before this investment which is not shown in this case study (which logically should be lower than >$20k compare to the COGS of Year 1 if they invest on the cereal fill machine).
3. Bare in mind, this case study is an investment project of "if" they invest on a new machine that also require additional cost to increase production to cater the increase of market demand.
   
2. Next point, that related to item 1 above “is inventory cost part of "cost of goods sold”?
1. The answer is "Yes" - Cost of goods sold consist of:
1. Inventory at the beginning of the year and at the end of the year
2. Purchases less cost of items withdrawn for personal use
3. Labor costs
4. Materials and supplies
5. others cost
2. But why the $10k increase cost of inventory is not in COGS??
1. It is because in Year 0, you do not factor in your COGS.
2. It only started to factor in Year 1 Cash Flow statement taking account of item 2.1 above (inventory/ labor/ material/ others)
3. Meanwhile, on your question concerning the “ Increased payable of $8000” you claimed “that it seems just the money owe to farmers and container company, but later Quaker Oats still need to fullfil the payable.”
1. You are right in a way, but they are something that we need to understand why this $8k is a “+” in cash flow.
2. First, Let’s understand what is payable or we can also call it as Accounts Payable (A/P):
1. A/P is a account that contains money that a person or company (in this case Quaker Oats (QO) is the company) owes to suppliers ( referring to farmers and Stone Container), but has not paid yet (a form of debt).
2. When QO receive an invoice - QO add it to the account, and then QO will only remove it when they pay.
3. A/P is a form of credit that the farmer and Stone Container offer to their purchaser – QO by allowing them (QO) to pay for their farm produce(wheat) or Storage service by Stone Container after it has already been received.
4. In other words (just to emphasize the key points):
1. A/P are amounts QO owe to their supplier (farmer and Stone Container) that are payable sometime within the near future — "near" meaning 30 to 90 days which is the payable period.
2. Using this payable period to slow down cash outflows can significantly improve your cash flow.
3. Therefore this $8k debt that haven’t been paid off is an added point (+) of QO as part of the money they owns.
4. And when QO pay the suppliers, the money will only factor in COGS in Year 1, Year 2, Year 3 and so on....
5. But still QO get the special privilege of $8k in their pocket (account) anytime as part of the deal or offer by doing business with the farmers and Stone Container.

This is as per my understanding. Correct me if I’m wrong.
Thanks.
Regards,
Edmond