Question

Cash Conversion Cycle

The HDL, Inc. balance sheet and income statement for the year ending 20xx are as follows:

Balance Sheet

(In millions of Dollars)

ASSETS

Cash                                     $6.0

Accounts Receivable              14.0

Average Inventory                   12.0

Fixed Assets, net                  40.0

                                            --------

TOTAL ASSETS                 $72.0

                                             =====

LIABILITIES AND EQUITY

Accounts Payable                $10.0

Salaries and Benefits Payable   2.0

Other current Liabilities            10.0

Long-term debt                         12.0

Equity                                     38.0

                                               --------

TOTAL EQUITY                     $72.0

                                              =====

Income Statement

(In millions of Dollars)

Net Sales                            $100.0

Cost of Sales                            60.0

Selling and admin. Expenses   20.0

Other Expenses                        15.0

                                             --------

EARNINGS AFTER TAXES   $5.0

                                            =====

Part 1 of 2:

A. determine the length of the inventory conversion period.

B. determine the length of the receivables conversion period.

C. determine the length of the operating cycle.

D. determine the length of the payables deferral period.

E. determine the length of the cash conversion cycle.

F. what is the meaning of the number that you calculated in part E?

Formulas:

Inventory Conversion Period (ICP)	Average Inventory
	-------------------------
	Cost of Sales/365
Receivables Conversion Period (RCP)	Accounts Receivable
	-------------------------
	Net Sales/365
Operating Cycle (OC)	ICP + RCP
Payables Deferral Period (PDP)	Accounts Payable + Salaries & Benefits
	-------------------------------------------------------
	Cost of Sales + Selling and admin. Expenses/365
Cash Conversion Cycle	OC - PDP

Cash conversion cycle exercise -- part 2 of 2 (Show your work in the Excel template):

You have made some calculations on the cash conversion cycle -- so you are a little comfortable with that process. Now, let’s say that you are in upper management, and you want to "tighten your ship" a little to increase your cash flow just on current operations. You ask for the following, reasonable goals:

1) A 10% decrease in average inventory.

2) A 10% decrease in accounts receivable.

3) A 10% increase in accounts payable.

While these adjustments are small and reasonable, redo your calculations and see just how much of a difference these small adjustments can make on the total cash conversion cycle.

Answer 1

Inventory Conversion Period = Average Inventory / (Cost of Sales/365)

We are given Average Inventory = $ 12 million and Cost of Sales = $ 60 million

Hence Inventory Conversion Period = 12/(60/365) = 73 days

Receivables Conversion Period = Accounts Receivables /(Net Sales/365)

We are given Accounts Receivables = $ 14 million and Net Sales = $ 100 million

Hence Receivables Conversion Period = 14/(100/365) = 51.1 days

Operating Cycle = ICP + RCP = (73 + 51.1) = 124.1 days

Payables Deferral Period = (Accounts Payables + Salaries & Benefits)/[(Cost of sales + Selling & Admin Expenses)/365]

We are given Accounts Payables = $ 10 million, Salaries & Benefits = $ 2 million, Selling & Admin Expenses = $ 20 million.

Hence Payables Deferral Period = (10+2)/[(60+20)/365] = 54.75 days

Cash Conversion Cycle = OC - PDP = (124.1 - 54.75) = 69.35 days

Cash conversion cycle (CCC) is simply the lenght of the time it takes for a company to convert its input purchases into cash through sales. It is a measure of time the company (working) capital is tied in the production process and it is sum of time required to convert the inventory into goods & sell them and then collect the receivables in cash minus the time available from suppliers to pay the company's liabilities

The excel worksheet showing the impact of the proposed changes is as below: