Question

Table 3 provides the most recent financial values for Firm Z. The CFO wants to implement strategic and operational changes that will lower the firm’s DSO to 40 days, DIH to 35 days, and increase DPO to 50 days. Assuming that these changes can be met without reducing revenues or CGS, calculate the resulting increase in operating cash flow due to reducing the CCC. Lastly, discuss any weaknesses in the model assumptions that might result in the projected increase in operating cash flow not materializing.

Table 3

	Most Recent Values for Firm Z
Accounts Receivable	$51
Inventory	$17
Accounts Payable	$13
Revenues	$150
CGS	$122

Answer 1

First, we calculate the current values of DSO, DIH and DPO

Current DSO = 365 / sales * accounts receivable = 365 / 150 * 51 = 124 days

Current DIH = 365 / CGS * inventory = 365 / 122 * 17 = 51 days

Current DPO = 365 / CGS * accounts payable = 365 / 122 * 13 = 39 days

Current CCC = DSO + DIH - DPO = 124 + 51 - 39 = 136 days

CCC after changes = DSO + DIH - DPO = 40 + 35 - 50 = 25 days

Increase in cash flow = (decrease in DSO / current DSO * Accounts receivable) + (decrease in DIH / current DIH * inventory) + (increase in DPO / current DPO * accounts payable)

Increase in cash flow = ((124 - 40) / 124 * $51) + ((51 - 35) / 51 * 17) + ((50 - 39) / 39 * 13) = $44

The model assumes that any decrease in current assets or any increase in current liabilities will result in direct affect on operating cash flow. However this may not be the case because current assets / liabilities may increase/decrease due other reasons and the cash flow effect may not materialize.