Cash Conversion Cycle: American products is concerned about managing cash effici

Question

Cash Conversion Cycle: American products is concerned about managing cash efficiently. On 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. Costs 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

Answer:

(a) Operating cycle = Average age of inventories + Average collection period = 90 days + 60 days = 150 days

(b) Cash Conversion Cycle = Operating cycle Average payment period = 150 days 30 days = 120 days

(c) Resources needed = (total annual sales÷ 365 days) × Cash conversion cycle

= ($30,000,000 ÷ 365) × 120 = $9,863,013.70

(d) By Shortening either the average age of inventory or the average collection period, lengthening the average payment period, or a combination of these can reduce the cash conversion cycle.

This can be done by:

T

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