In: Finance
CASH CONVERSION CYCLE
Parramore Corp has $13 million of sales, $2 million of inventories, $4 million of receivables, and $2 million of payables. Its cost of goods sold is 70% of sales, and it finances working capital with bank loans at an 6% rate. Assume 365 days in year for your calculations. Do not round intermediate steps.
Cash conversion cycle is the period of time is takes for the company to convert its inventory into sales and conversion of sales into cash | |||
Formula to calculate cash conversion cycle | |||
Cash conversion cycle = Inventory conversion period + Average collection period - Average payable period | |||
Calculation of inventory conversion period | |||
Inventory conversion period | Inventory/Cost of goods sold per day | ||
Inventory conversion period | 2000000/((13000000*0.70)/365) | 80.22 | days |
Average collection period | Accounts receivables/Sales per day | ||
Average collection period | 4000000/(13000000/365) | 112.31 | days |
Average payable period | Payables/Cost of goods sold per day | ||
Average payable period | 2000000/((13000000*0.70)/365) | 80.22 | days |
Cash conversion cycle | 80.22+112.31-80.22 | 112.31 | days |
Calculation of new cash conversion cycle | |||
New inventory | 2000000*0.93 | $1,860,000 | |
New accounts receivable | 4000000*0.93 | $3,720,000 | |
New payable | 2000000*1.07 | $2,140,000 | |
Inventory conversion period | Inventory/Cost of goods sold per day | ||
Inventory conversion period | 1860000/((13000000*0.70)/365) | 74.60 | days |
Average collection period | Accounts receivables/Sales per day | ||
Average collection period | 3720000/(13000000/365) | 104.45 | days |
Average payable period | Payables/Cost of goods sold per day | ||
Average payable period | 2140000/((13000000*0.70)/365) | 85.84 | days |
Cash conversion cycle | 74.60+104.45-85.84 | 93.22 | days |
New conversion cycle is 93.22 days | |||
Calculation of amount of cash freed up | |||
Inventory | (Old inventory conversion period - New inventory conversion period)*Cost of goods sold per day | ||
Inventory | (80.22-74.60)*((13000000*0.70)/365) | ||
Inventory | $140,000.00 | ||
Receivables | (Old collection period - New collection period)*Sales per day | ||
Receivables | (112.32-104.45)*(13000000/365) | ||
Receivables | $280,000.00 | ||
Payables | (Old payable period - New payable period)*Cost of goods sold per day | ||
Payables | (80.22-85.84)*(13000000*0.70)/365) | ||
Payables | $140,000.00 | ||
Cash freed up = Inventory + receivables - Payables | |||
Cash freed up = 140,000+280000-140000 | |||
Cash freed up | $280,000.00 | ||