Question

Increased Efficiency, Inc. is looking for ways to shorten its cash conversion cycle. It has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. The firm's cost of goods sold is 75% of sales. On average, the company has $9,000,000 in inventory and $8,000,000 in accounts receivable. Its CFO has proposed new policies that would result in a 20% reduction in both average inventories and accounts receivable. She also anticipates that these policies would reduce sales by 10%, while the payables deferral period would remain unchanged at 40 days. What effect would these policies have on the company's cash conversion cycle? Enter your answer rounded to two decimal places. For example, if your answer is 12.345 then enter as 12.35 in the answer box.

Answer 1

	Current	Proposed
Annual sales	$ 36,500,000.00	$          32,850,000.00
Days basis	365	365
Sales per day	$      100,000.00	$                 90,000.00
Cost of good sold (75% of sales)	$ 27,375,000.00	$          24,637,500.00
Average Inventory	$   9,000,000.00	$            7,200,000.00
Average Accounts Receivables	$   8,000,000.00	$            6,400,000.00
Payable deferral period	40	40	days
Cash conversion cycle = days inventory outstanding + days sales outstanding - days payable outstanding.
Days Inventory Outstanding = (Inventory /Cost of Sales )*365	120	106.67	days
Days Sales Outstanding = (Accounts Receivables/Sales)*365	80	71.11	days
Days Payable outstanding = (Accounts Payable/ cost of Sales)*365	40	40	days
Cash conversion Cycle	160	137.78	days
The new proposed policy would reduce the cash conversion cycle by (160-137.78)	22.22	days