Although the assumption that operating assets and operating liabilities grow proportionally to sales is a very...

Although the assumption that operating assets and operating liabilities grow proportionally to sales is a very good approximation for most companies, there are a few circumstances that might require more complicated modeling techniques. We describe four possible refinements in section 12-8: economics of scale, nonlinear relationships, lumpy purchases of assets, and excess capacity adjustments. However, always keep in mind that additional complexity in a model might not be worth the incremental improvement in accuracy.

a.which items comprise operating current assets Why is it reasonable to assume that they grow proportionally to sales?

b.What are some reasons that net PP&E might grow proportionally to sales, and what are some reasons that it might not?

c.What are spontaneous liabilities?

Expert Solution

a.Operating assets include both current assets & fixed assets, that are acquired & aid ,during the conduct of the core operation, for which the business was established.

Here, the items of current assets include---cash, accounts receivables,inventory and all prepaid assets.

It is only highly reasonable to state that all of the above grow proportionately to sales, some of them,if not in a very direct proportion--they increase with sales.

For example, if more sales is made, either cash increases or accounts receivable increase.

Inventory needs to be increased to meet the demand.

Prepaid assets like insurance for inventory received or sent ,increases due to more activity.

b. PP& E will grow ,if the current capacity utilisation of the same is 100% & sales increase need to met with creating additional fixed asset acquisition. In that case, PP&E will grow proportionately with sales.

Whereas,

If the existing PP&E facilities are working below capacity, & there is scope for more units that can be produced (in which case ,sales can be increased), PP&E will not grow proportionately to that increased sales.

c.Spontaneous liabilities are current liabilities that which increase spontaneously,with increase in sales.

For example, accounts payable increase due to increased cost of goods sold, like increased cost of merchandise purchased.

Also accrued liabilities like payment for establihmnet charges like , water, electricity or direct wages to shopfloor workers increase due to increased production , to meet increased the level of sales.

All the above increase naturally, when sales increase.

jeff jeffy answered 8 months ago

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