Edison Inc. has annual sales of $36,500,000, or $100,000 a day on a 365-day basi

Question

Edison Inc. has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. The firm's cost of goods sold is 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.

Explanation / Answer

Cost of Goods Sold = 0.75* sales = $27,375,000

Inventory Conversion period = Avg Inventory / (COGS /365) = 120 days

Receivable conversion period = accounts receivable /(sales/365) = 80 days

so Cash Conversion cyccle = 120 + 80 - 35 = 165 days ;

Now sales reduced by 10 %

sales/day = 90,000

Avg inventory = 0.8*9,000,000 = 7,200,000

accounts receivabe = 0.8*8,000,000 = 6,400,000 ;

COGS = 0.75*90,000 = 67,5000

so

Inventory Conversion period = Avg Inventory / (COGS /365) = 106.6667

Receivable conversion period = accounts receivable /(sales/365) = 71.111

Cash Conversion cycle = 106.67 +71.11 - 35 = 142.778 days

It reduced by 165 - 142,778 = 22.22 days

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