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

Calculation of cash conversion cycle
Cash conversion cycle	Days in inventory + Average collection period - Average payable period
Days in inventory	Inventory/Cost of goods sold per day
Days in inventory	9000000/((36500000*75%)/365)
Days in inventory	9000000/75000
Days in inventory	120.00	days
Average collection period	Accounts receivable/Sales per day
Average collection period	8000000/100000
Average collection period	80.00	days
Average payable period	40 days	(Given)
Cash conversion cycle	120+80-40
Cash conversion cycle	160.00	days
Revised sales	$32,850,000	36500000*90%
Cost of goods sold	$24,637,500	32850000*75%
Sales per day	$90,000	32850000/365
Cost of goods sold per day	$67,500	24637500/365
Calculation of new CCC
Days in inventory	Inventory/Cost of goods sold per day
Days in inventory	(9000000*0.80)/67500
Days in inventory	7200000/67500
Days in inventory	106.67	days
Average collection period	Accounts receivable/Sales per day
Average collection period	(8000000*0.80)/90000
Average collection period	6400000/90000
Average collection period	71.11	days
Cash conversion cycle	106.67+71.11-40
Cash conversion cycle	137.78	days
The change in policy would reduce cash conversion cycle from 160 days to 137.78 days