Question

1- Explain the Cash Conversion Cycle (CCC).

2- PV calculation of short term cash flow,

A firm will make a $10,000,000 credit sale payable within 45 days with payment received on Day 45; it has a discount rate of 6%. What is the PV with this payment term?

3- AFNWC calculation,

A company makes the following forecast for 2018:

-Revenues increase by 10% from 2017 sales of $4,000,000;

-Receivables were $400,000 in 2017, it is usually about 10% of revenues;

-Inventory was at $600,000, and it historically equals to 15% of revenues;

-Payables are usually $200,000, and it is expected at 5% of revenues.

a)What will be the sales level for 2018?

b)What will be the inventory, receivable and payable increase for 2018, based on the sales forecast. ?

c)What will be the additional funds needed for working capital (AFNWC) ?

Answer 1

Answer 1:

Cash conversion cycle is the duration in terms of days a company takes to convert its investment in inventory and other resources into cash from its sales.

Cash conversion cycle (CCC) = Days Inventory outstanding (DIO) + Days Sales outstanding (DSO) - Days payable outstanding (DPO)

It is the length of time from the day company pays cash for inventories to the time it gets back cash from its credit sales.

Inventory management, Receivable management and payable management are three key ingredients of CCC. It defines the working capital requirement and also helps assess liquidity risk of company's operation.

Answer 2:

Credit sales = $10,000,000

Credit period = 45 days

Discount rate = 6%

PV = 10000000 / (1 + 6% * 45/365)

= $9,926,570.57

PV = $9,926,570.57

Answer 3(a):

Revenues increases by 10% from 2017 sales of $4,000,000

Sales level for 2018 = $4,000,000 * (1 + 10%) = $4,400,000

Sales level for 2018 = $4,400,000

Answer 3(b):

Receivables = 10% of revenue

Inventory = 15% of revenue

Payable = 5% of revenue

Revenues increases by 10% from 2017 sales of $4,000,000 =10% * $4,000,000 = $400,000

Hence:

Receivables increase = 10% * 400000 = $40,000

Inventory increase = 15% * 400000 = $60,000

Payable increase = 5% * 400000 = $20,000

Answer 3(b):

Additional funds needed for working capital (AFNWC) = Receivable increase + Inventory increase - Payable increase

= $40,000 + $60,000 - $20,000  

= $80,000

AFNWC = $80,000