Question

While trying to understand the equation, I had a question about spontaneous liabilities. On pg. 481, the spontaneous liabilities-to-sales ratio summarizes that this will reduce the need for external financing, for example, by paying suppliers in 20 days rather than 10 days. How does changing paying a supplier 10 days later play a part in allowing a company to forecast its sales?

Answer 1

Given satetement

the spontaneous liabilities-to-sales ratio summarizes that this will reduce the need for external financing means if we pay before the payment period, then the firm can reduce its investment in operations.

For example,Company had an average payment period of 35 days (consisting of 30 days until payment was mailed and five days of payment float), which resulted in average accounts payable of $467 466. Thus, the daily accounts payable generated by company was $13 356 ($467 466/35). If they were to mail its payments in 35 days instead of 30, its accounts payable would increase by $66 780 ($13 356 × 5). As a result, their cash conversion cycle would decrease by five days, and the firm would reduce its investment in operations by $66 780.