Question

J-Born Berhad has an annual sale of RM25 million and due to pandemic Covid 19, it’s
expected that the sales for the next year will reduce by 20%. Its cost of goods sold (COGS) is
60% of its sales. Currently its inventory conversion period (ICP) is 122 days, its average
collection period (ACP) is 60 days and its accounts payable is 15% from its sales. The firm is
trying to restrict its credit policy and increase it sales. The firm will give incentives to its
staffs if they can improve the firm financials.
The top management expected that the inventory will reduce by 15%, the accounts receivable
will reduce by 25% and its accounts payable will increase by 20%. (Hint: can use round off
number)

Required:
a. What is the current cash conversion cycle (CCC)?


b. What is the new CCC and the net change?


c. Advise to the top management the action required to improve on the firm financial.


d. Is the firm credit policy improve between these two years? What is the effect if the firm
does not concern on this problem?

Answer 1

a. Calculation of Current Cash conversion cycle.

Cash Conversion Cycle = ICP+ ACP - APP

ICP( Inventory Conversion Period) = 122days

ACP ( Average Collection Period) = 60days

APP( Average Payment Period) = Account Payable/ Sales × 365

Sales =RM 25million

Account Payable = 15% of Sales = 15% × RM 25million

APP = (15%×RM 25million )/ RM 25million × 365

APP= 54.75 days or 55days(approx)

Cash Conversion Cycle= 122days+ 60days- 55days = 127days

Current Cash Conversion Cycle = 127days

b. New Cash Conversion Cycle

Particulars	Old Cash Conversion Cycle	New Current Assets/liabilities	New Cash Conversion Cycle
Inventory Conversion Period	ICP = Inventory/COGS ×365 ICP =122 days COGS = 60% of Sales =60%× RM25million =RM 15million ICP = Inventory/ 15×365 122= Inventory /RM15million ×365 Inventory = 122 × RM 15 million/ 365 Inventory =RM 5.01 million	New Inventory = 15% decrease in old Inventory = (100-15)% RM 5.01 million = 85% × RM 5.01 million = RM 4.26 million	New ICP = New Inventory/ New COGS ×365 New Inventory = RM 4.26million COGS = 60% of New sales New Sales = RM 25million × (100-20)% =RM 25million ×80% =RM 20million New COGS = 60% ×RM 20Million =RM 12million ICP = RM 4.26/ RM 12million × 365 = 129.57 days or 130days
Average Collection Period	ACP = Account Receivable/ sales ×365 ACP = 60 days Sales RM 25million Account Receivable= ? 60 = Account Receivable/ RM 25million ×365 Account Receivable = 60×RM 25million / 365 Account Receivable = RM 4.109 million	New Account Receivable = 25% decrease in old Account Receivable =(100-25)%× RM 4.109million = 75%×RM 4.109million = RM 3.082million	New ACP = New Account Receivable/ Sales × 365 New ACP = RM 3.082/RM 20million ×365 New ACP = 56.24 OR 56 days
Account Payable Period	Account Payable = 15% of Sales Account Payable = 15%×RM 25 million = RM 3.75million	New Account Payable = 20% Increase in Account Payable =(100+20)% × RM 3.75 million =120% ×RM 3.75 million =RM 4.5 million	APP = New Account Payable/ New Sales ×365 New APP = RM 4.5million / RM 20million ×365 = 82.12 days or 82days

New Cash Conversion Cycle = New ICP + New ACP - New APP

= 130days + 56days - 82days

New Cash Conversion Period = 104 days

Net Change = old cash Conversion Period - New Cash Conversion Period

= 127days - 104 days = 23days (shorter).

c.Increasing Sales of Inventory for Profit is the Primary way for Management to make more earning. A management can acquire Inventory on credit which result Account Payable and also sell product on credit which result in Account Receivable. So Inventory Management, sales realisation and Payable are the three key element of business.if any of these goes for a toss, say Inventory mismanagement, Sales constraints or payable increasing in number or value the business is set to suffer.

To improve the financial aspects of firm manager must reduced it's Inventory Collection Period and Account Receivable Period and try to avail more Account Payable Period from the supplier.

d.Yes, From table b we can observe that credit policy has changed alot. Firm Account Receivable Period has decreased which reflect quick sales realisation and on other hand, Account Payable Period has increased to 82 days that shows firm has enough time to make payment to its creditors/ Account Payable. Timing is an important aspect of cash management.If inventory management, Sales realisation or payable goes off or mismanaged it would lead to major financial break down in the Firm. Effective management is needed in this three key ingredients - ICP,ACP and APP.