Question

Network Solutions just introduced a new, fully automated manufacturing plant that produces 2,000 wireless routers per day. The average number of days a router is held in inventory before being sold is 45 days. In addition, they generally pay their suppliers in 30 days, while collecting from their customers after 25 days.

     a. The cash conversion cycle is how many days?

b. What would happen to the cash conversion cycle if they could stretch their payments to suppliers from 30 days to 50 days?

Answer 1

Solution:

Cash conversion cycle indicates the time taken by an organization / company to convert its inventory/ Finished goods into cash.

The cash conversion cycle shall be calculated as follows:

Cash conversion cycle = Inventory holding period + Receivables (Debtors) collection period - Credit period allowed by suppliers (Creditors)

a.

As per the data available for Network solutions in the given question:

Inventory holding period = 45 days

Receivables (Debtors) collection period = 25 days

Credit period allowed by suppliers (Creditors) = 30 days

Hence Cash conversion cycle = 45 + 25 – 30 = 40 days.

b.

If the payments to suppliers is stretched from 30 days to 50 days ;

The new cash conversion cycle would be = 45 + 25 -50 =   20 days.

Thus the cash conversion cycle would be shorter by a period of 20 days if the payments to suppliers is stretched to 50 days .