Camp Manufacturing turns over its inventory five times each year, has an average

Question

Camp Manufacturing turns over its inventory five times each year, has an average payment period of 35 days, and has an average collection period of 60 days. The firm has annual sales of $3.5 million and cost of goods sold of $2.4 million.

Calculate the firms operating cycle and cash conversion cycle.

What is the dollar value of inventory held by the firm?

If the firm could reduce the average age of its inventory from 73 days to 63 days, by how much would it reduce its dollar investment in working capital?

Explanation / Answer

1.Calculation of Operating and cash conversion cycle:

Operating Cycle = Days Sales Outstanding + Days Inventory Outstanding - Days Payable Outstanding

Days Inventory Outstanding = 365 / Inventory Turnover Ratio

Days Inventory Outstanding = 365 / 5 = 73 Days

Operating Cycle = 60 + 73 + 35 = 168 Days

Cash Conversion Cycle = Operating Cycle - Days Payable Outstanding

Cash Conversion Cycle = 60 + 73 - 35 = 98 Days

2. Dollar Value of the Inventory = Cost of Goods Sold / Inventory Turnover Ratio

Dollar Value of the Inventory = 2,400,000 / 5 = $480,000

3. New Inventory Turnover Ratio in this Case = 365 / 63 = 5.79 Times

New Dollar Value of the Inventory = 2,400,000 / 5.79 = $414,508

Inventory reduced by 480,000 - 414,508 = $65,492

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