Question

Ingram Inc. carries an average inventory of $1,125,000. Its annual sales are $15 million, its cost of goods sold is 75% of annual sales, and its average collection period is twice as long as its inventory conversion period. The firm buys on terms of net 30 days, and it pays on time. Its new CFO wants to decrease the cash conversion cycle by 10 days, based on a 365-day year. He believes he can reduce the average inventory to $970,890 with no effect on sales. By how much must the firm also reduce its accounts receivable to meet its goal in the reduction of the cash conversion cycle?

A) $230,137, B) 136.986 C) 205,479 D) 251,027

Answer 1

Answer: C ) $ 205,479.

Workings:

Inventory Conversion Period = ( 365 / Cost of Goods Sold) x Average Inventory = ( 365 / 15,000,000 x 0.75) x $ 1,125,000 = ( 365 / 11,250,000) x 1,125,000 = 36.5 days.

Average Collection Period = 36.5 days x 2 = 73 days.

Average Receivables = $ 15,000,000 / 5 = $ 3,000,000.

Payables Deferral Period = 30 days.

Existing Cash Conversion Cycle = 36.5 days + 73 days - 30 days = 79.5 days.

Proposed Cash Conversion Cycle = 69.5 days.

Proposed Inventory Conversion Period = ( 365 / 11,250,000) x 970,890 = 31.50 days.

Proposed Average Collection Period = 69.50 days + 30 days - 31.50 days = 68 days.

Expected Receivables Turnover = 365 / 68 days = 5.36764706

Average receivables required = $ 15,000,000 / 5.36764706 = $ 2,794,521

Reduction in Accounts Receivable required = $ 3,000,000 - $ 2,794,521 = $ 205,479.