Question

Camp Manufacturing turns over its inventory five times each year, has an average payment period of 35 days, and has an average collection period of 60 days. the firm has annual sales of $4.2 million and cost of goods sold of $3.5 million.

a.Calculate the firm's operating cycle and cash conversion cycle.

b.What is the dollar value of inventory held by the firm?

c.If the firm could reduce the average age of its inventory from 73 days to 63 days by how much would it reduce its dollar investment in working capital?

Answer 1

a.
Calculation of inventory days
Inventory days = 365/Inventory turnover
Inventory days	73	days
Operating cycle = Inventory days + Average collection period
Operating cycle	73+60
Operating cycle	133	days
Cash conversion cycle = Operating cycle - Average payment period
Cash conversion cycle	133-35
Cash conversion cycle	98	days
The operating cycle is 133 days and cash conversion cycle is 98 days
b.
Calculation of dollar value of inventory held by the firm using inventory turnover formula
Inventory turnover	Cost of goods sold/Inventory
5 = $3.5 million/Inventory
Inventory	3.5/5
Inventory	$0.70	million
Thus the dollar value of inventory is $700,000
c.
Calculation of inventory when inventory days is 63 days
Inventory days	(Inventory/Cost of goods sold)*365
63 = (Inventory/3.5)*365
63*3.50 = 365*Inventory
220.50 = 365*Inventory
Inventory	0.6041096	million
Thus the new inventory level would be $604,109.60
The total reduction in dollar investment in working capital = 700,000-604,109.60
Total reduction	$95,890.41
The reduction in dollar investment in working capital is $95,890.41