Question

The following company has sales of $30 million and a cost of goods sold of $18 million. The balance sheet for period ending 31 December 2018 for this company appears below

Assets                                                      $000	Liabilities and Shareholder Equity      $000
Cash                                                         2500	Accounts Payable                                    1600
Accounts Receivable                             4400	Other Payables                                           900
Inventory                                                1500	Accruals                                                      1100
Total Current Assets                            8400	Total Current Liabilities                          3600
Property Plant and Equipment         10500	Long Term Debt                                        2500
Total Assets                                         18900	Total Liabilities                                         6100
	Issued Equity                                           12800
	Total Liability & Shareholder Equity 18900

a. Calculate the company’s net working capital in 2018.                                     

b. Calculate the company’s cash cycle for 2018.

c. The industry average for accounts receivable is 28 days. What would this company’s cash cycle have been in 2018 if it had matched this industry average for accounts receivable? Comment on this new cash cycle outcome against b. above.

Answer 1

Net Working Capital(Current Assets - Current Liabilities)
Net Working Capital for 2018 =$8,400,000 - $3,600,000 =$4,800,000
Cash Conversion Cycle =Days inventory outstanding(DIO) + Days sales outstanding(DSO) - Days payable outstanding(DPO)
Note:Since Average of Inventory, Accounts Receivable can't be computed here,Hence we will use the closing figures of 2018.
DIO =(Average Inventory / Cost of goods sold)*365
DSO =(Average Accounts Receivable / Net Sales)*365
DPO =(Average Accounts Payable / Cost of goods sold)*365
DIO for Current Year =($1,500,000 / $18,000,000)*365 =30 days
DSO for Current Year =($4,400,000 / $30,000,000)*365 =54 days
DPO for Current Year =($1,600,000 / $18,000,000)*365 =32 days
Cash Conversion Cycle for Current Year =30 + 54 + 32 =116 days
If the Industry average for accounts Receivable is 28 days then the cash conversion cycle shall be 90 days(30+28+32)
The cash conversion cycle as per industry average is lower than the Actual cash cycle of the company for 2018. Which means
that the company is not utilising it's cash as per the industry standards and is less efficient in management of cash