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Again, the amount closed from the income summary to retained earnings must always equal the net income/loss as reported on the income statement. The $36 debit to interest payable will cause the Interest Payable account to go to zero since the liability no longer exists once the cash is paid. Notice that the total interest expense recorded on the bank loan was $39 – $18 expensed in January, $18 expensed in February, and $3 expensed in March. LO2 – Explain the use of and prepare the adjusting entries required for prepaid expenses, depreciation, unearned revenues, accrued revenues, and accrued expenses. As a result of this entry, salaries expense is reported on the January income statement when cash is paid. A shorter operational cycle is preferable since the firm has adequate cash to keep operations running, recoup investments, and satisfy other commitments.

• This helps maintain a steady cash flow, reduces the risk of bad debts, and ensures you have funds available for immediate use or investment.
• In contrast, the increase in the time duration will allow the business to hold some cash or goods in advance.
• Average inventory is found by dividing the sum of beginning and ending inventory balances found on the balance sheet.
• By effectively managing the operating cycle, businesses can optimize their working capital utilization.
• The truck and equipment purchased by Big Dog Carworks Corp. in January are examples of plant and equipment assets that provide economic benefits for more than one accounting period.
• BrightStar Tech specializes in providing software solutions to small and medium-sized businesses.
• Days inventories outstanding equals the average number of days in which a company sells its inventory.

This strategic focus on operational efficiency enables companies to adapt to market dynamics, capitalize on emerging opportunities, and withstand economic fluctuations. Assume that BrightStar Tech has an inventory turnover period of 60 days, an accounts receivable period of 45 days, and an accounts payable period of 30 days. Understanding how an operating cycle works and being able to calculate it can provide valuable insights for businesses looking to optimize their processes and ultimately create a more productive work environment.

Effective Accounts Payable Strategies

The above adjusting entry enables the company to match the income tax expense accrued in January to the income earned during the same month. BDCC also shows https://www.bookstime.com/ a truck for $8,000 on the January 31, 2023 unadjusted trial balance. There is no change in the days required to convert inventory to accounts receivable.

Days inventories outstanding equals the average number of days in which a company sells its inventory. Days sales outstanding, on the other hand, is the average time period in which receivables pay cash. A high DPO suggests that your company is effectively managing its accounts payable, optimizing cash flow by extending payment terms without straining supplier relationships. This can be particularly beneficial for businesses looking to reduce working capital requirements and enhance profitability.

Importance of the Operating Cycle in Business

After 4 years, the asset will likely be sold (journal entries related to the sale of plant and equipment assets are discussed in Chapter 8). The cost less estimated operating cycle residual value is the total depreciable cost of the asset. The straight-line method allocates the depreciable cost equally over the asset’s estimated useful life.

This means that companies can reduce or eliminate slow-moving or obsolete inventory, which in turn reduces the cost and time needed to dispose of these items. The companies with high operational efficiency are typically those that provide goods or services with short shelf lives i.e., clothing, electronics, etc. In this sense, the operating cycle provides information about a company’s liquidity and solvency.