Question

Consider the case of Teal Monkey Manufacturers:

Teal Monkey Manufacturers is a mature firm that has a stable flow of business. The following data was taken from its financial statements last year:

Annual sales	$10,500,000
Cost of goods sold	$6,825,000
Inventory	$3,200,000
Accounts receivable	$2,100,000
Accounts payable	$2,700,000

Teal Monkey’s CFO is interested in determining the length of time funds are tied up in working capital. Use the information in the preceding table to complete the following table. (Note: Use 365 days as the length of a year in all calculations, and round all values to two decimal places.)

	Value
Inventory Conversion Period	A.) 68.13 Days B.) 48.67 Days C.) 171.14 Days D.) 55.16 Days
Average collection period	A.) 23.00 Days B.) 20.44 Days C.) 73.00 Days D.) 28.11 Days
Payables Deferral Period	A.) 46.54 Days B.) 114.40 Days C.) 52.01 Days D.) 62.96 Days
Cash conversion cycle	A.) 32.12 Days B.) 37.47 Days C.) 99.74 Days D.) 42.83 Days

Both the inventory conversion period and payables deferral period use the average daily COGS in their denominators, whereas the average collection period uses average daily sales in its denominator. Why do these measures use different inputs?

A.) Current assets should be divided by sales, but current liabilities should be divided by the COGS.

B.) Inventory and accounts payable are carried at cost on the balance sheet, whereas accounts receivable are recorded at the price at which goods are sold.

The management at Teal Monkey Manufacturers wants to continue its internal discussions related to its cash management. One of the finance team members presents the following case to his cohorts:

Case in Discussion

Red Hamster Manufacturing’s management plans to finance its operations with bank loans that will be repaid as soon as cash is available. The company’s management expects that it will take 60 days to manufacture and sell its products and 50 days to receive payment from its customers. Red Hamster’s CFO has told the rest of the management team that they should expect the length of the bank loans to be approximately 110 days.

Which of the following responses to the CFO’s statement is most accurate?

A.) The CFO is not taking into account the amount of time the company has to pay its suppliers. Generally, there is a certain length of time between the purchase of materials and labor and the payment of cash for them. The CFO can reduce the estimated length of the bank loan by this amount of time.

B.) The CFO’s approximation of the length of the bank loans should be accurate, because it will take 110 days for the company to manufacture, sell, and collect cash for its goods. All these things must occur for the company to be able to repay its loans from the bank.

Answer 1

1. Inventory conversion period=(Inventory/cost of goods sold)*365=(3200000/6825000)*365=171.14 days

2. Average collection period=(Accounts receiavbles/Sales)*365=(2100000/10500000)*365=73 days

3. Payables Defferal period=(accounts payables/Cost of goods sold)*365=(2700000/6825000)*365=144.40 days

4. Cash conversion cycle=Average collection period+ Inventory conversion period-Payables Defferal period=73+171.14-144.40=99.74 days

5. Option B is correct

Inventory and accounts payable are carried at cost on the balance sheet, whereas accounts receivable are recorded at the price at which goods are sold. Hence, the mechanism to calculate these days

6. Option B is correct

They should consider 110 days because this is the time that it takes to receive the cash from the customers. After getting amount only they can pay to the banks and suppliers. Hence 110 days should be accurate.