Question

Below are financials for XYX Corporation (in million $):

Sales	$330		Cash	$    6		Accounts Payable	$   64
COGS	260		Accounts Receivable	72		Long term debt	119
SG&A	12		Inventory	40		Common stock	50
EBIT	58		Net fixed assets	241		Retained earnings	126
Interest	11		Total assets	$359		Total Equity & Liab.	$359
EBT	47
Tax	14
Net Income	$ 33

The firm's inventory conversion period is 56 days. Its new CFO wants to decrease the cash conversion cycle by 8 days, based on a 365-day year. He believes he can reduce average receivables by $2.7 million without upsetting customers.

a. By how much must the firm increase its average payable to meet its goal of a 8-day reduction in its cash conversion cycle? (6 points)

b. If XYZ Corporation does decrease its cash conversion cycle by 8 days by increasing average payables and reducing average receivables, what will be the change in its net operating working capital? The company's inventory remains constant.  (2 points)

Answer 1

following formula is used for calculation of cash conversion cycle (CCC)

CCC=Days sales oustanding + Days of Inventory on Hand - Numbar of days payable

As per above formula:

Days sales oustanding = 365* Account Reciveables / Sales

= 365 *72 / 330 = 79.64 days

Days of Inventory on Hand = 365* Average inventory / COGS

= 365 *40 / 260 = 56.15 day ( can be used 56 as already rounding off is done in question)

Numbar of days payable = 365* Account Payables / COGS

= 365*64 / 260 = 89.85

Now CCC = 79.64+56.15-89.85 = 45.94 (rounding to 46 days)

a.

now as per question, CCC is to be reduced by 8 days then new CCC = 46-8=38 days

reducing average recivable by $ 2.7 million hence new average recivables = 72-2.7 = 69.3

so new Days sales oustanding = 365 * 69.3/330 (using above mentioned formula

= 76.65

using cash converiosn cycle formula

CCC=Days sales oustanding + Days of Inventory on Hand - Numbar of days payable

38 = 76.65+56.15 - Number of days of payable

Number of days of payable=94.8

365* Account Payables / COGS = 94.8

Account payables =94.8 *COGS / 365

=94.8*260 / 365 = 67.53

Hence increase in Account payables = 67.53 - 64 = $ 3.53 million

b.

Net operating working capital = Cash + Account Receivable + Inventory - Account Payables

In original case Net operating working capital = 6 + 72 + 40 - 64 (data taken from question)

= $ 54 Million

In original case Net operating working capital = 6 + 69.3 + 40 - 67.53

= $ 47.77 Million

Hence change in Net Operating working Capital = 54-47.77 = $ 6.23 Million

Net Operating working Capital will be reduced by $ 6.23 Million.