Question

Cash conversion cycle American Products is concerned about managing cash effi-ciently. On average, inventories have an age of 80 days, and accounts receivable are collected in 40 days. Accounts payable are paid approximately 30 days after they arise. The firm has annual sales of about $30 million. Goods sold total $20 million, and purchases are $15 million. a. Calculate the firm’s operating cycle. b. Calculate the firm’s cash conversion cycle. c. Calculate the amount of resources needed to support the firm’s cash conversion cycle. d. Discuss how management might be able to reduce the cash conversion cycle

Answer 1

Answer a.

Operating Cycle = Average Inventory Period + Average Receivable Period
Operating Cycle = 80 days + 40 days
Operating Cycle = 120 days

Answer b.

Cash Conversion Cycle = Operating Cycle - Average Payable Period
Cash Conversion Cycle = 120 days - 30 days
Cash Conversion Cycle = 90 days

Answer c.

Average Inventory Period = 365 * Inventory / Cost of Goods Sold
80 = 365 * Inventory / $20,000,000
Inventory = $4,383,561.64

Average Receivable Period = 365 * Accounts Receivable / Sales
40 = 365 * Accounts Receivable / $30,000,000
Accounts Receivable = $3,287,671.23

Average Payable Period = 365 * Accounts Payable / Cost of Goods Sold
30 = 365 * Accounts Payable / $20,000,000
Accounts Payable = $1,643,835.62

Resources Needed = Inventory + Accounts Receivable - Accounts Payable
Resources Needed = $4,383,561.64 + $3,287,671.23 - $1,643,835.62
Resources Needed = $6,027,397.25

Answer d.

The management might be able to reduce the cash conversion cycle by decreasing average receivable period or by increasing average payable period.