Cash conversion cycle American Products is concerned about managing cash efficie

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 on 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 might be able to reduce the cash conversion cycle.

Explanation / Answer

a)

Firm operating cycle:

= Days of inventory outstanding+Days sales outstanding

= 90 days+60 days

= 150 days

b)

Cash conversion cycle:

= Days of inventory outstanding+Days sales outstanding+Days payable outstanding

= 90 days+60 days-30 days

= 120 days

c)

Amount of resources required to support cash conversion cycle:

= 90×$5 million÷365+60days×$30 million÷365-30×$15 million÷365

= $4.93 million

d)

It should try to reduce the inventory levels and credit period allowed to accounts receivables should be decreases as far as possible. And also it needs to negotiate with suppliers for further extension of credit period.

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