Question

You have recently been hired to improve the performance of Shortage Inc. which has been experiencing a severe cash shortage. As one part of your analysis, you want to determine the firm's cash conversion cycle. Using the following information, what is your estimate of the firm's current cash conversion cycle?

Current inventory = $150,000

Accounts receivable = $220,000

Accounts payable = $140,000

Annual sales = $1,200,000

Cost of Goods Sold = $600,000

Purchases credit terms: net 30 days

Receivables credit terms: net 45 days

Answer 1

(1) The time lag between the purchase of raw materials and the sale of finished goods is the inventory period or Days inventory outstanding.

Days inventory outstanding =( Inventory/ Cost of goods sold) * 365 = (150000/600000)*365 =91.25 days

(2) The time that elapses between the date of sales and date of collection of receivables is the accounts receivable period or Days sales outstanding.

Days sales outstanding=( Accounts receivable /Net credit sales.) * 365 =(220000/1200000)*365 = 66.92 days

(3) The time that elapses between the date of purchase of materials and date of payment for materials is the accounts payable period or Days payable outstanding.

Days payable outstanding= (Accounts payable/ Cost of sales) * 365 =(140000/600000)*365 = 85.17 days

Cash conversion cycle = Days inventory outstanding + Days sales outstanding - Days payable outstanding

=91.25+66.92-85.17

=73 days