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 70% 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? Enter your answer rounded to two decimal places. For example, if your answer is 12.345 then enter as 12.35 in the answer box.

Answer 1

Answer:
Existing policies:
Days Sales Outstanding = Accounts Receivable / Sales * 365
Days Sales Outstanding = $8,000,000 / $36,500,000 * 365
Days Sales Outstanding = 80 days

Cost of Goods sold = $36,500,000 * 70%
Cost of Goods sold = $25,550,000

Days Inventory Outstanding = Inventory / Cost of Goods sold * 365
Days Inventory Outstanding = $9,000,000 / $25,550,000 * 365
Days Inventory Outstanding = 128.57 days

Days Payable Outstanding = 40 days

Cash Conversion Cycle = Days Sales Outstanding + Days Inventory Outstanding - Days Payable Outstanding
Cash Conversion Cycle = 80 days + 128.57 days – 40 days
Cash Conversion Cycle = 168.57 days

Proposed policies:
Proposed Sales = $36,500,000 – ($36,500,000 * 10%)
Proposed Sales = $32,850,000

Proposed Accounts Receivable = $8,000,000 – ($8,000,000 * 20%)
Proposed Accounts Receivable = $6,400,000

Proposed Inventory = $9,000,000 – ($9,000,000 * 20%)
Proposed Inventory = $7,200,000

Proposed Cost of Goods sold = $32,850,000 * 70%
Proposed Cost of Goods sold = $22,995,000

Days Sales Outstanding = Accounts Receivable / Sales * 365
Days Sales Outstanding = $6,400,000 / $32,850,000 * 365
Days Sales Outstanding = 71.11 days

Days Inventory Outstanding = Inventory / Cost of Goods sold * 365
Days Inventory Outstanding = $7,200,000 / $22,995,000 * 365
Days Inventory Outstanding = 114.29 days

Days Payable Outstanding = 40 days

Cash Conversion Cycle = Days Sales Outstanding + Days Inventory Outstanding - Days Payable Outstanding
Cash Conversion Cycle = 71.11 days + 114.29 days – 40 days
Cash Conversion Cycle = 145.40 days

The Cash conversion cycle would reduce by 23.17 days (168.57 days – 145.40 days) if policy is implemented.