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

Answer: Projected increase in operating cash flows : $ 36.16

This looks very good on paper, but the company would face some hurdles along the way.

Reducing DSO from 124 days to 40 days might not be too easy. The average collection period has to decrease drastically, and that might have a negative impact on sales.The company would also have to spend more to effect the increase in receivables turnover.

Similarly, reducing DIH from 51 days to 35 days might not be too easy, specially if there are only few suppliers of inventory, or the inventory needs to be imported. Implementation of JIT would help, but that would entail additional capital expenditure.

Increasing the DPO from the current level of 39 days to 50 days would need intense negotiations with suppliers, and foregoing of purchase discounts.

Computations:

Proposed accounts receivable = 40 / 365 * 150 = $ 16.44

Proposed inventory = 35 / 365 * 122 = $ 11.69

Proposed accounts payable = 50 / 365 * 122 = $ 16.71

Decrease in accounts receivable = $ ( 51 - 16.44) = $ 34.56

Decrease in inventory = $ ( 17 - 11.69) = $ 5.31

Increase in accounts payable = $ ( 16.71 - 13 ) = $ 3.71

Increasing in operating cash flows = $ ( 34.56 + 5.31 + 3.71) = $ 36.16