Question

A firm is considering the following changes: increasing inventory variety, which will

increase inventory to $60,000, and offering more liberal sales terms, which will result in

average receivables increasing to $65,000. These actions are expected to increase sales to

$800,000 per year, and cost of goods will remain at 75%. Because of the increased

purchases, average payables will increase to $35,000.

1. What effect will these changes have on the cash conversion cycle?

2. What three actions can a firm take to minimize its net working capital?

Answer 1

sales		800000
cost of sales-75% of sales		600000
gross profit		200000
accounts receivable collection period =(365*average receivable)/sales	(365*65000)/800000	30
Inventory holding period =(365*average inventory)/cost of sales	(365*60000)/600000	37
account payable payment period =(365*average accounts payable)/cost of sales	(365*35000)/600000	21
cash conversion cycle = accounts receivable collection period+inventory holding period-accounts payable payment period	30+37-21	46
This change will increase the cash conversion cycle by 46 days
Three actions that reduce the investment in net working capital (1) early collection of funds from receivables (2) less investment in inventory (3) late payment of accounts payable