Question

Cash conversion cycle

Cash management is a very important function of managers. Companies need to manage their operations in a way that they can sustain growth and yet not run out of cash.

Consider the case of the Loud Noise Recordings Corporation:

Loud Noise Recordings Corporation has forecasted sales of $27,000,000 for next year and expects its cost of goods sold (COGS) to remain at 70% of sales. Currently, the firm holds $3,200,000 in inventories, $1,900,000 in accounts receivable, and $2,700,000 in accounts payable.

Approximately how long does it take Loud Noise Recordings to convert its raw materials to its finished products and then to sell those goods? (Note: In all calculations, assume that there are 365 days in a year.)

A-46.35 days

B-61.80 days

C-52.53 days

D-43.26 days

On average, it takes x days from the time a sale is made until the time cash is collected from customers.

Loud Noise Recordings relies on customer credit when it buys raw materials from its suppliers. On average, it takes x days after the firm purchases materials before it sends cash to its suppliers.

Answer 1

Sales = 27000000

COGS = 70%*27000000 = 18900000

Inventory turnover = COGS/Inventory

= 18900000/3200000

= 5.9063

Days inventory on hand = Number of days in period/Inventory turnover

= 365/5.9063 = 61.80 days

Therefore number of days it takes to convert its raw materials to its finished products and then to sell those goods = 61.80 days.

Receivable turnover = Revenue/Accounts receivable

= 27000000/1900000 = 14.2105

Days of sales outstanding = Number of days in period/Receivable turnover

= 365/14.2105

= 25.69 days

Therefore it takes 25.69 days from the time a sale is made until the time cash is collected from customers.

Payables turnover = Sales / Payables

= 27000000/2700000 =10

Number of days of payables = Number of days in period/Payables turnover

= 365/10 = 36.5 days

Therefore it takes 36.5 days after the firm purchases materials before it sends cash to its suppliers.