Zervos Inc. had the following data for 2008 (in millions). The new CFO believes
ID: 2682714 • Letter: Z
Question
Zervos Inc. had the following data for 2008 (in millions). The new CFO believes (1) that an improved inventory management system could lower the average inventory by $4,000, (2) that improvements in the credit department could reduce receivables by $2,000, and (3) that the purchasing department could negotiate better credit terms and thereby increase accounts payable by $2,000. Furthermore, she thinks that these changes would not affect either sales or the costs of goods sold. If these changes were made, by how many days would the cash conversion cycle be lowered?Original Revised
Annual sales: unchanged $124,000 $124,000
Cost of goods sold: unchanged $80,000 $80,000
Average inventory: lowered by $4,000 $20,000 $16,000
Average receivables: lowered by $2,000 $16,000 $14,000
Average payables: increased by $2,000 $10,000 $12,000
Days in year 365 365
Answer 36.3
39.6
39.2
33.3
34.6
Explanation / Answer
The formula for calculating the Cash conversion cycle is
CCC = DIO + DSO - DPO
Where DIO represents Days inventory Outstanding
DSO represents Days Sales Outstanding
DPO represents Days Payable outstanding
Cash conversion cycle impact by inventory reduction
DIO = (Average inventory / Cost of goods sold) * 365
Original DIO = ($20,000/$80,000) *365 =91.25 days
Revised DIO= ($16,000/$80,000 *365) = 73 days
Cash conversion cycle impact by reduced accounts receivable
DPO = (Accounts payable / Cost of goods sold) * 365
Original DPO =($10,000/$80,000)*365 = 45.625 days
Revised DPO = ($12,000/$80,000) *365 = 54.75 days
Cash conversion cycle impact by increased a/c payable
DSO = (Total receivables / Total credit sales) * 365
Original DSO = ($16,000/$110,000 *365) = 53.09 days
Revised DSO = ($14,000/$110,000 *365) = 46.45 days
CCC = DIO + DSO – DPO
Original CCC = 91.25 + 53.09 – 45.63 = 98.71 days
Revised CCC = 73 + 46.45 – 54.75 = 64.7 days
Total impact = original CCC – Revised CCC = 98.71 – 64.7 = 34.01 days
So, cash conversion cycle will be lowered by 34.0 days
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