Question

2.     [Cash Conversion Cycle] Castillo Products Company improved its operations from a net loss in 2015 to a net profit in 2016. While the founders, Cindy and Rob Castillo, are happy about these developments, they are concerned with trying to understand how long the firm takes to complete its cash conversion cycle in 2016. Use the following financial statements to make your calculations. Balance sheet items should reflect the averages of the 2015 and 2016 accounts.

CASTILLO PRODUCTS COMPANY
INCOME STATEMENT		2015	2016
Net sales		$900,000	$1,500,000
Cost of goods sold		540,000	900,000
Gross profit		360,000	600,000
Marketing		90,000	150,000
General and administrative		250,000	250,000
Depreciation		40,000	40,000
EBIT		–20,000	160,000
Interest		45,000	60,000
Earnings before taxes		–65,000	100,000
Income taxes		0	25,000
Net income (loss)		–$65,000	$ 75,000
BALANCE SHEET	2015			2016
Cash	$ 50,000			$ 20,000
Accounts receivable	200,000			280,000
Inventories	400,000			500,000
Total current assets	650,000			800,000
Gross fixed assets	450,000			540,000
Accumulated depreciation	–100,000			–140,000
Net fixed assets	350,000			400,000
Total assets	$1,000,000			$1,200,000
Accounts payable	$ 130,000			$160,000
Accruals	50,000			70,000
Bank loan	90,000			100,000
Total current liabilities	270,000			330,000
Long-term debt	300,000			400,000
Common stock (0.05 par)	150,000			150,000
Additional paid-in-capital	200,000			200,000
Retained earnings	80,000			120,000
Total liabilities and equity	$1,000,000			$1,200,000

A.   Calculate the inventory-to-sale conversion period for 2016.

B.   Calculate the sale-to-cash conversion period for 2016.

C. Calculate the purchase-to-payment conversion period for 2016.

D. Determine the length of the Castillo Product’s cash conversion cycle for 2016.

Answer 1

Ans. Calculation of Average Inventory for the year of 2016

Opening Inventory = 400000

closing inventory    = 500000

Average inventory = 900000/2 = 450000

Cost of goods per day in 2016 = 900000/365 = 2466 per day

Inventory conversion period = 450000/2466 = 183 days

Ans. B Calculation of sale to cash conversion period for 2016 = Receivable /net credit sale

Step1: Average account receivable = (200000+280000)/2 = 240000

Step 2: Sale to cash conversion period for 2016 = 240000/1500000 X365 = 58days

Ans. C Calculation of purchase to payment coversion period for 2016

Average Account payable = (130000+160000)/2 = 145000

Calculation of purchase for the year

Closing stock    = 500000

COGS                  = 900000

Less: Op stock = (400000)

Purchase amt    =   1000000

Purchase to payment conversion period = 145000/1000000X365 = 53 days

Ans D. Cash conversion cycle for 2016 = DIO+DSO-DPO

DIO = Days of Inventory oustanding   = 183 days

DSO= Days of sales outstanding       = 58 days

DPO= Days of purchase outstanding = 53 days

Cash conversion cycle for 2016 = 183+58-53 = 188 days