Question

Australian Products Ltd. is concerned about managing cash in an efficient manner. On average, inventories have an average age of 90 days and accounts receivable are collected in 60 days. Accounts payable are paid approximately 30 days after they arise. The firm spends $30 million on operating cycle (OC) investments each year, at a constant rate. Assuming a 365-day year:

1. Calculate the firm’s OC.
   
2. Calculate the firm’s CCC.
   
3. Calculate the amount of financing required to support the firm’s CCC.
   
4. Discuss how management might be able to reduce the CCC.
   

Answer 1

Inventories have an average age = 90 days

Accounts receivable are collected in = 60 days

Accounts payable are paid approximately 30 days

Firm spends (OC) investments each year =$30 million

Time period = 365-day year:

a) Calculating the firm’s OC.

Average age + Accounts receivable

= 90 days + 60 days

=150 DAYS

b)Calculating the firm’s CCC.

operating cycle - Accounts payable

= 150 Days - 30 Days

= 120 Days

C) Calculating amount of financing required to support the firm’s CCC.

Inventory

investments * average age/ Time period

= $30,000,000*90/365

= $7,397,260.27

Accounts receivable = $30,000,000*60/365

= $4,931,506.86

Accounts Payable = $30,000,000*30/365

=$2,465,753.42

Invested

Inventory +  Accounts Payable

= $7,397,260.27 + $2,465,753.42

= $9,863,013.

D)

The cash exchange cycle can be overcome by improving the payable time and reducing the receivable time.