Question

6.   Jiffy Park Corp. has annual sales of $50,705,000, an average inventory level of $15,015,000, and average accounts receivable of $10,015,000. The firm's cost of goods sold is 85% of sales. The company makes all purchases on credit and has always paid on the 30th day. However, it now plans to take full advantage of trade credit and to pay its suppliers on the 40th day. The CFO also believes that sales can be maintained at the existing level but inventory can be lowered by $1,950,000 and accounts receivable by $1,950,000.

      a.   What is Jiffy Park’s cash conversion cycle (CCC) prior to the changes proposed?

      b.   What is Jiffy Park’s CCC after implementing the suggested changes?

      c.   What is the net change in Jiffy Park’s CCC given what you just calculated above?

Answer 1

First of all lets understand how is cash conversion cycle or CCC is computed.

Cash Conversion cycle = days of sales outstanding + days of inventory outstanding - days of payable outstanding

Days of sales outstanding = (Average debtors / Net credit sales) x 365 (Assuming number of days in a year to be 365.). It denotes the time on average is taken by the company to collect cash from its debtors.

Days of Inventory Outstanding =  (Average inventory / Cost of goods sold) x 365 (Assuming number of days in a year to be 365.). It denotes how much time on average is required by the company to sale its inventory.

Days of payable outstanding = (Average creditors / Net credit purchases) x 365 (Assuming number of days in a year to be 365.). It denotes how much time the creditors have allowed to the company to make payment to them.

Now we shall answer the questions:

a.) Cash Conversion Cycle prior to changes proposed = days of sales outstanding + days of inventory outstanding - days of payable outstanding

Days of sales outstanding using the formula mentioned above = (10015000 / 50705000) x 365 = 72 days

Days of Inventory outstanding using the formula mentioned above = (15015000 / 50705000 x 85%) x 365 = 127 days

Days of payables outstanding using the formula mentioned above = Already provided in the question i.e. 30 days

So, cash conversion cycle = 72 + 127 -30 = 169 days

b) Cash Conversion Cycle after the proposed changes = days of sales outstanding + days of inventory outstanding - days of payable outstanding

Days of sales outstanding using the formula mentioned above = (10015000 - 19,50,000) / 50705000) x 365 = 58 days

Days of Inventory outstanding using the formula mentioned above = (15015000 - 19,50,000 / 50705000 x 85%) x 365 = 111 days

Days of payables outstanding using the formula mentioned above = Already provided in the question i.e. 40 days

So, cash conversion cycle = 58 + 111 - 40 = 129 days

c) Net change in cash conversion cycle = 169 days - 129 days = 40 days.