Cash conversion cycle American Products is concerned about managing cash efficie
ID: 2802983 • Letter: C
Question
Cash conversion cycle American Products is concerned about managing cash efficiently. On the average, inventories have an age of 87 days, and accounts receivable are collected in 66 days. Accounts payable are paid approximately 31 days after they arise. The firm has annual sales of about
$40 million. Cost of goods sold are $18 million, and purchases are $13million.
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 be able to reduce the cash conversion cycle.
Explanation / Answer
Answer a.
Operating Cycle = Average Age of Inventory + Average Collection period
Operating Cycle = 87 + 66
Operating Cycle = 153 days
Answer b.
Cash Conversion Cycle = Operating Cycle – Average Payable period
Cash Conversion Cycle = 153 - 31
Cash Conversion Cycle = 122 days
Answer c.
Resources Invested = Amount Invested in Inventory + Amount Invested in Accounts Receivable – Amount due to Payable
Amount Invested in Inventory = 18,000,000 * 87 / 365 = $4,290,410
Amount Invested in Accounts Receivable = 40,000,000 * 66 /365 = $7,232,876
Amount due to Payable = 13,000,000 * 31/365 = $1,104,109
Resources Invested = $4,290,410 + $7,232,876 - $1,104,109
Resources Invested = $10,419,177
Answer d.
Management might be able to reduce the cash conversion cycle by reducing the amount of resources being invested into it.
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