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How is the operating cycle calculated based on the days' sales in inventory and accounts receivable?
Days' sales in inventory only
Days' sales in accounts receivable only
The sum of days' sales in inventory and accounts receivable
The average of days' sales in inventory and accounts receivable
The correct answer is: The sum of days' sales in inventory and accounts receivable
The operating cycle is an important metric that measures the time it takes a company to purchase inventory, sell it, and collect cash from customers. It essentially reflects the efficiency of a company's operations in managing inventory and receivables. To calculate the operating cycle, you add the number of days it takes to sell inventory (days' sales in inventory) to the number of days it takes to collect cash from accounts receivable (days' sales in accounts receivable). This sum gives you the total time from when inventory is acquired to when cash is collected from sales. By understanding this calculation, businesses can better manage their cash flows and operational efficiency. The operating cycle becomes crucial for understanding liquidity and ensuring that the company has enough working capital to fund its ongoing ops. The calculation does not involve taking only the days' sales in inventory or accounts receivable in isolation, nor does it consider an average of the two, as those methods would not provide the complete picture of the time involved in the overall operating cycle. Thus, the correct answer reflects the comprehensive nature of the operating cycle by combining both elements.