Edison Inc. has annual sales of $49,000,000, or $44,100,000 a day on a 365-day b

Question

Edison Inc. has annual sales of $49,000,000, or $44,100,000 a day on a 365-day basis. The firm's cost of goods sold are 75% of sales. On average, the company has $9,000,000 in inventory and $8,000,000 in accounts receivable. The firm is looking for ways to shorten its cash conversion cycle. Its CFO has proposed new policies that would result in a 20% reduction in both average inventories and accounts receivable. She also anticipates that these policies would reduce sales by 10%, while the payables deferral period would remain unchanged at 35 days. What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.

a. –19 days

b. –16 days

c. –17 days

d. –18 days

e. –20 days

Explanation / Answer

Sales per day = $44,100,000 COGS = 75% of Sales = 0.75*44,100,000 = $33,075,000 cash conversion cycle CCC = DIO + DSO - DPO Days Inventory Outstanding (DIO): This addresses the question of how many days it takes to sell the entire inventory. The smaller this number is, the better. DIO = Average inventory/COGS per day = $9,000,000/($33,075,000/365) = 99days Days Sales Outstanding (DSO): This looks at the number of days needed to collect on sales and involves AR. While cash-only sales have a DSO of zero, people do use credit extended by the company, so this number is going to be positive. Again, smaller is better. DSO = Average AR / Revenue per day = $8,000,000/($44,100,000/365) =66 days Days Payable Outstanding (DPO): This involves the company's payment of its own bills or AP. If this can be maximized, the company holds onto cash longer, maximizing its investment potential; therefore, a longer DPO is better. DPO = Average AP / COGS per day = 35 days SO cash conversion cycle CCC = DIO + DSO - DPO = 99+66-35 = 130 days...(A) Post new policy :- Avge inventory will reduce by 20% = 0.80*$9M = $7.2M Avge A/R = 0.80*$8M = $6.4M New Sales will be 0.90*$44,100,000 = $39,690,000 New COGS = 75% of sales = 0.75*39690000 = $29,767,500 DIO = Average inventory/COGS per day = $7,200,000/($29,767,500/365) = 88 days DSO = Average AR / Revenue per day = $6,400,000/($39,690,000/365) =59 days DPO = Average AP / COGS per day = 35 days SO cash conversion cycle CCC = DIO + DSO - DPO = 88+59-35 = 112 days...(B) So CCC has reduced by (A) - (B) = 130-112 = 18 days So Ans is d. –18 days

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