Question

3. Compute the cash cycle and each of its components for ATC in 2019.

ATC Company
Balance Sheet on December31 ($ millions)
	2018	2019
Inventory	20	28
Accounts Receivable	36	26
Other	29	36
Cash	410	473
Total Current Assets	495	562
NPPE	1,847	2,237
Other Fixed Assets	156	212
Total Fixed Assets	2,003	2,449
Total Assets	2,499	3,011
Short Term Debt and Notes	152	173
Accounts Payable	27	28
Other	334	412
Total Current Liabilities	514	613
Long Term Debt	1,119	1,249
Other Long Term Liabilities	175	266
Total Long Term Liabilities	1,294	1,515
Common Equity	690	884
Total Liabilities & Equity	2,499	3,011

Income Statement for Year Ending December 31 ($ millions)
	2018	2019
Total revenues	1,667	1,841
Cost of sales	1,250	1,297
Gross profit	417	544
Selling, general & admin expenses	174	180
Operating profit	243	364
Net interest expense	45	64
Other income (expense)	0	2
Income before tax	199	301
Taxes	38	69
Net Income	162	232

Answer 1

Cash Cycle = Days of Inventory Turnover + Days of Receivables Turnover - Days of Payables Turnover

Days of Inventory Turnover = 365 / Inventory Turnover Ratio , where
Inventory Turnover Ratio = Cost of Goods Sold/ Average Inventory

Therefore, Days of Inventory Turnover = 365*Average Inventory / (Cost of Goods Sold)
This explains the time taken by the inventory to be sold on an average or how many times in a year is the inventory getting turn around in the company .

Days of Receivables  Turnover = 365/ Receivables Turnover Ratio , where
Receivables Turnover Ratio = Credit Sales / Average Receivables

Therefore, Days of Receivables Turnover = 365* Average Receivables/ Credit Sales
This ratio expains the times taken by the credit sales to be converted into cash.
Higher it is, the better it is which means, sales are converting into cash faster and company has good clientel base and good recovery tema . Whereas lower ratio indicates, company is slow in recovering from its debtors and the receivables cycle might increase posing a risk to the business.

Days of PayableTurnover = 365/ Payables Turnover Ratio , where
Payable Turnover Ratio = Credit Purchase / Average Payables

Therefore, Days of Payable Turnover = 365* Average Payables / Credit Purchases
This ratio expains the times taken to pay off for the credit purchases made by the business/ comapny.
Higher ratio indicates, company is paying off its creditors faster i.e. company is cash rich and has sufficient reserves.
However, when it is low, it means company is taking more time to pay off its creditors which might be a sign of risk.


From the Values given in the question,

Days of Inventory Turnover = 365*Average Inventory / (Cost of Goods Sold)
= (365* (20+28) /2 ) /1297
= 365*24 / 1297
= 6.75
= ~7 Days

​​​​​​​Days of Receivables Turnover ​​​​​​​= 365*Average Receivables / (Credit Sales)
= (365* (36+26) /2 ) /1841
= 365*31/ 1841
= 6.15
= ~6 Days

​​​​​​​Days of Payables Turnover ​​​​​​​= 365*Average Payables/ (Credit Purchases )
= (365* (27+28) /2 ) / 1297
= 365*27.5 / 1297
= 7.74
= ~8 Days

Therefore, Cash Cycle = Days of Inventory Turnover + Days of Receivables Turnover - Days of Payables Turnover
= 7 + 6 - 8
= 5 Days

Therefore, ATC's cash cycle is of 5 days