Cash management is a very important function of managers. Companies need to mana

Question

Cash management is a very important function of managers. Companies need to manage their operations in a way that they can sustain growth and yet not run out of cash Consider the case of the Red Hamster Manufacturing Corporation Red Hamster Manufacturing Corporation has forecasted sales of $28,000,000 for next year and expects its cost of goods sold (COGS) to remain at 70% of sales. Currently, the firm holds $3,200,000 in inventories, $2,100,000 in accounts receivable, and $2,400,000 in accounts payable Approximately how long does it take Red Hamster Manufacturing to convert its raw materials to its finished products and then to sell those goods? (Note: In all calculations, assume that there are 365 days in a year.) 59.59 days 62.57 days O 53.63 days O 41.71 days On average, it takes from the time a sale is made until the time cash is collected from customers Red Hamster Manufacturing relies on customer credit when it buys raw materials from its suppliers. On average, it takes after the firm purchases materials before it sends cash to its suppliers What is the length of Red Hamster Manufacturing's cash conversion cycle (CCC)? O 48.62 days O 50.74 days 46.51 days O 42.28 days

Explanation / Answer

Sales = 28,000,000

COGS = 19,600,000    (70% of 28,000,000)

Inventory = 3,200,000

Accounts Receivables = 2,100,000

Accounts Payable = 2,400,000

Days inventory Outstanding = Inventory/COGS * 365

Days inventory Outstanding = 3,200,000/19,600,000 * 365

Days inventory Outstanding = 59.59................(Answer to first question)

Days Debtors Outstanding = Accounts Receivables/Sales * 365

Days Debtors Outstanding = 2,100,000/28,000,000 * 365

Days Debtors Outstanding = 27.38................(Answer to first blank)

Days Creditors Outstanding = Accounts Payables/COGS * 365

Days Creditors Outstanding = 2,400,000/19,600,000 * 365

Days Creditors Outstanding = 44.69................(Answer tosecond blank)

Cash Conversion Cycle = Days inventory Outstanding + Days Debtors Outstanding - Days Creditors Outstanding

Cash Conversion Cycle (CCC) = 59.59 + 27.38 – 44.69 = 42.28

Case

The second option is accurate response CFO's statement - The CFO is not taking into account the amount of time the company has to pay its suppliers. There is a time gap between the purchase of raw material and payment made to the suppliers. Considering this time would reduce the company's casgh conversion cycle and bank loan can be paid before 90 days.

Yes, it is possible to have negative cash flow. If a company hold inventory for very less time and converts its inventory into sales in days less than the days it takes to pay to the creditors, its CCC will be negative. The best example is amazon, it does not hold inventory, make sales, recieves cash upfront from the customers and pays takes time to pay to the suppliers, hence its CCC is always negative.

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