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?

Answer 1

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AS FOR GIVEN DATA..

EXPLANATION:

Cost of goods sold = $36500000 x 75% = $27375000

Cash conversion cycle = Days sales outstanding + Days inventory oustanding - Days payable outstanding

Days sales outstanding = (Accounts receivable / sales) x 365

= (8000000 / 36500000) x 365 = 80 days

Days inventory outstanding = (Inventory / Cost of goods sold) x 365

= ($9000000 / 27375000) x 365 = 120 days

Days payable outstanding = 40 days

Cash conversion cycle = 80 + 120 - 40 = 160 days

New Scenario

Sales = $36500000 x 90% = $32850000

Cost of goods sold = $32850000 x 75% = $24637500

Inventory = $9000000 x 80% = $7200000

Accounts receivable = $8000000 x 80% = $6400000

Days sales outstanding = (6400000 / 32850000) x 365 = 72 days

Days inventory outstanding = (7200000 / 24637500) x 365 = 107 days

Cash conversion cycle = 72 + 107 - 40 = 139 days

These policies have decreased the cash conversion cycle from 160 days to 139 days

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