Cash conversion cycle: American Products is concerned about managing cash effici
ID: 2653898 • Letter: C
Question
Cash conversion cycle: American Products is concerned about managing cash efficiently. On the average, inventories have an age of 90 days, and accounts receivable are collected in 60 days. Accounts payable are paid approximately 30 days after they arise. The firm has annual sales of about $30 million. Cost of goods sold are $20 million, and purchases are $15 million.
a. Calculate the firm's operating cycle.
b. Calculate the firm's cash conversion cycle.
c. Calculate the amount of resources needed to support the firm's cash conversion cycle.
d. Discuss how management might be able to reduce the cash conversion cycle.
Explanation / Answer
Cash conversion cycle: American Products is concerned about managing cash efficiently. On the average, inventories have an age of 90 days, and accounts receivable are collected in 60 days. Accounts payable are paid approximately 30 days after they arise. The firm has annual sales of about $30 million. Cost of goods sold are $20 million, and purchases are $15 million.
a. Calculate the firm's operating cycle.
Firm's operating cycle. = Average Inventory Period + Average Collection Period
Firm's operating cycle. = 90 +60
Firm's operating cycle. = 150 Days
b. Calculate the firm's cash conversion cycle.
Firm's cash conversion cycle = Firm's operating cycle. - Average Payment Period
Firm's cash conversion cycle = 150-30
Firm's cash conversion cycle = 120 Days
c. Calculate the amount of resources needed to support the firm's cash conversion cycle.
Inventory = Cost of Good Sold* Average Inventory Period /360
Inventory = 20 *90/360
Invenory = $ 5 Million
Account recievable = Sales*Average Collection Period/360
Account recievable = 30*60/360
Account recievable = $ 5 Million
Accounts payable = Purchases*average Payment period/360
Accounts payable = 15*30/360
Accounts payable = $ 1.25 Million
Amount of resources needed to support the firm's cash conversion cycle = Inventory + Account recievable - Accounts payable
Amount of resources needed to support the firm's cash conversion cycle = 5 + 5 - 1.25
Amount of resources needed to support the firm's cash conversion cycle = $ 8.75 Million
d. Discuss how management might be able to reduce the cash conversion cycle.
Management might be able to reduce the cash conversion cycle by following activities:
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