Question

Increased Efficiency, Inc. is looking for ways to shorten its cash conversion cycle. It has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. The firm's cost of goods sold is 65% of sales. On average, the company has $9,000,000 in inventory and $8,000,000 in accounts receivable. Its CFO has proposed new policies that would result in a 20% reduction in both average inventories and accounts receivable. She also anticipates that these policies would reduce sales by 10%, while the payables deferral period would remain unchanged at 40 days. What effect would these policies have on the company's cash conversion cycle?

I got 24 days and would like to confirm my answer. Thank you

Answer 1

CCC = Days of Sales Outstanding PLUS Days of Inventory Outstanding MINUS Days of Payables Outstanding.

DSO = AVERAGE RECEIVABLES/NET SALES *365  

OLD DSO :(BEFORE POLICY) = 8000000/36500000*365 = 80 DAYS

NEW DSO : WITH POLICY = 6400000/32850000*365 = 71 DAYS (71.11)

INVENTORY OUTSTANDING = AVERAGE INVENTORY/NET SALES*365

OLD DIO :(BEFORE POLICY) =9000000/36500000*365 = 90 DAYS

NEW DIO : WITH POLICY =7200000/32850000*365= 80 DAYS

PAYABLE DEFFERAL PERIOD = AVERAGE CREDITORS/ COST OF GOODS SOLD*365

40 =AVERAGE CREDITORS/ 23725000*365

AVERAGE CREDITORS= 23725000*40/365 =2600000

WHICH REMAIN SAME BEFORE AND AFTER POLICY

CASH CONVERSION PERIOD BEFORE POLICY = 80+90-40 = 130 DAYS (2.81 TIMES A YEAR)

CASH CONVERSION PERIOD AFTER POLICY = 87+71-40 = 118 DAYS (3.09 TIMES A YEAR)