Consider the case of Teal Monkey Manufacturers:
Teal Monkey Manufacturers is a mature firm that has a stable flow of business. The following data was taken from its financial statements last year:
Annual sales | $10,500,000 |
Cost of goods sold | $7,140,000 |
Inventory | $2,800,000 |
Accounts receivable | $1,800,000 |
Accounts payable | $2,800,000 |
Teal Monkey’s CFO is interested in determining the length of time funds are tied up in working capital. Use the information in the preceding table to answer the following questions. (Note: Use 365 days as the length of a year in all calculations, and round all values to two decimal places.)
What is the value of the inventory conversion period?
57.79 days
63.87 days
143.14 days
54.75 days
Both the inventory conversion period and payables deferral period use the average daily COGS in their denominators, whereas the average collection period uses average daily sales in its denominator. Why do these measures use different inputs?
Inventory and accounts payable are carried at cost on the balance sheet, whereas accounts receivable are recorded at the price at which goods are sold.
Current assets should be divided by sales, but current liabilities should be divided by the COGS.
What is the average collection period?
62.57 days
24.63 days
25.81 days
22.29 days
What is the payables deferral period?
63.87 days
143.14 days
66.91 days
69.95 days
What is the cash conversion cycle?
26.98 days
62.57 days
28.15 days
25.81 days
1.
Inventory conversion period = (Inventory / cost of goods sold) *
365
= ($2,800,000 / $7,140,000) * 365
= 143.14 days
Inventory conversion period = 143.14 days
2.
Average collection period = (Accounts receivable / credit sale) *
365
= ($1,800,000 / $10,500,000) * 365
= 62.57 days
3.
Payables deferral period = (Accounts payable / cost of goods sold)
* 365
= ($2,800,000 / $7,140,000) * 365
= 143.14 days
4.
Cash conversion cycle = Inventory conversion period + Average
collection period - Payables deferral period
= 143.14 + 62.57 - 143.14
= 62.57 days
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