Question

. Cash conversion cycle

Cash management is a very important function of managers. Companies need to manage their operations in a way that they can sustain growth and yet not run out of cash.

Consider the case of the Red Hamster Manufacturing Corporation:

Red Hamster Manufacturing Corporation has forecasted sales of $28,000,000 for next year and expects its cost of goods sold (COGS) to remain at 80% of sales. Currently, the firm holds $3,100,000 in inventories, $1,900,000 in accounts receivable, and $2,600,000 in accounts payable.

Approximately how long does it take Red Hamster Manufacturing to convert its raw materials to its finished products and then to sell those goods? (Note: Use 365 days as the length of a year in all calculations, and round all values to two decimal places.)

50.51 days

42.93 days

37.88 days

47.98 days

On average, it takes    from the time a sale is made until the time cash is collected from customers.

Red Hamster Manufacturing relies on customer credit when it buys raw materials from its suppliers. On average, it takes    after the firm purchases materials before it sends cash to its suppliers. The length of Red Hamster Manufacturing’s cash conversion cycle (CCC) is     . In general, firms prefer a   CCC.

What is the length of Red Hamster Manufacturing’s cash conversion cycle (CCC)?

37.85 days

34.56 days

32.91 days

29.62 days

In general, firms prefer a   CCC.

The management at Red Hamster Manufacturing wants to continue its internal discussions regarding its cash management. One of the finance team members presents the following case to her cohorts:

Case in Discussion

Black Sheep Broadcasting Company’s management plans to finance its operations with bank loans that will be repaid as soon as cash is available. The company’s management expects that it will take 50 days to manufacture and sell its products and 40 days to receive payment from its customers. Black Sheep Broadcasting Company’s CFO has told the rest of the management team that they should expect the length of the bank loans to be approximately 90 days.

Which of the following responses to the CFO’s statement is most accurate?

The CFO is not taking into account the amount of time the company has to pay its suppliers. Generally, there is a certain length of time between the purchase of materials and labor and the payment of cash for them. The CFO can reduce the estimated length of the bank loan by this amount of time.

The CFO’s approximation of the length of the bank loans should be accurate, because it will take 90 days for the company to manufacture, sell, and collect cash for its goods. All these things must occur for the company to be able to repay its loans from the bank.

Is it possible for a firm to have a negative CCC?

Yes

No

Answer 1

Cash conversion cycle

Red Hamster Manufacturing Corporation has forecast ed sales of $28,000,000 for next year

expects its cost of goods sold (COGS) to remain at 80% of sales

Currently, the firm holds $3,100,000 in inventories, $1,900,000 in accounts receivable, and $2,600,000 in accounts payable.

cash conversion cycle (CCC) = Days inventory outstanding + Average collection period - Days Payables Outstanding (DPO)

Approximately how long does it take Red Hamster Manufacturing to convert its raw materials to its finished products and then to sell those goods?

Days inventory outstanding = Inventory / COGS per day

Here,

Inventory = 3,100,000

COGS per day = Cogs / 365

Total COGS = 80% of sales =28000000 * 80% = 22400000

COGS per day    = 22400000 / 365 = 61369.86

Days inventory outstanding = 3100000 / 61369.86 = 50.51 days

On average, it takes    from the time a sale is made until the time cash is collected from customers.

Average collection period = Average Receivables / Sales per days

Here,

Average Receivables = 1,900,000

Sales per days = sales / 365

Sales = 28000000 / 365 = 76712.328

Average collection period = 1,900,000 / 76712.328 = 24.77 days

On average, it takes    after the firm purchases materials before it sends cash to its suppliers.

Days Payables Outstanding (DPO) = Average Payables / COGS per day

Here,

Average Payables = 2,600,000

COGS per day = 22400000 / 365 = 61369.86

Days Payables Outstanding (DPO) = 2,600,000 / 61369.86 = 42.37 days

What is the length of Red Hamster Manufacturing’s cash conversion cycle (CCC)?

cash conversion cycle (CCC) = Days inventory outstanding + Average collection period - Days Payables Outstanding (DPO)

cash conversion cycle (CCC) = 50.51 + 24.77 - 42.37 = 32.91 days

Which of the following responses to the CFO’s statement is most accurate?

>> The CFO’s approximation of the length of the bank loans should be accurate, because it will take 90 days for the company to manufacture, sell, and collect cash for its goods. All these things must occur for the company to be able to repay its loans from the bank.

Is it possible for a firm to have a negative CCC?

>> Yes,

Because, The firm earn and spend cash only when someone pays the company or when the company pay someone else. That's why a negative cash cycle is possible. If the company can postpone paying the company’s supplier until after the company collect cash for selling the goods, The company have achieved negative CCC