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 80% 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? Enter your answer rounded to two decimal places. For example, if your answer is 12.345 then enter as 12.35 in the answer box.

Answer #1

Cash Conversion Cycle (CCC) = DIO + DSO − DPO

DSO = D x (AR / S)

This is where:

*D*is the number of days*AR*is the accounts receivable. For the computation we use 80% since it says the AR shall be reduced by 20%*S*is the sales. For this we use 90% since it says sales it to be reduced by 10%.

DSO = [365 x [($8,000,000 x 0.8)/($36,500,000 x 0.9)] = 365 x 0.1948 = 71.11

DIO = D x [I / COGS]

*I*is the inventory. For the computation we use 80% since it says the inventory shall be reduced by 20%*COGS*is the cost of goods sold

DIO = 365 x [($9,000,000 x 0.80) / ($36,500,000 x 0.9 x 0.80)] = 365 x 0.2740 = 100

Cash Conversion Cycle (CCC) = 100 + 71.11 - 40 = 131.11

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