Question

Increased Efficiency, Inc. is looking for ways to shorten its cash conversion cycle. It 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 65% of sales. On average, the company has $9,000,000 in inventory and $8,000,000 in accounts receivable. 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 40 days. What effect would these policies have on the company's cash conversion cycle? Enter your answer rounded to two decimal places. For example, if your answer is 12.345 then enter as 12.35 in the answer box.

Answer 1

Particulars	Original	Proposed	Remarks
Annual sales	$                              36,500,000	$                              32,850,000	proposed plan sales = $36,500,000 x (1-0.10)
days in a year	365	365
Sales per day	$                                    100,000	$                                      90,000	Annual sales ÷ days in a year
COGS as a % of sales	65%	65%	given
COGS per day	$                                      65,000	$                                      58,500	Sales per day x COGS % on sales
Inventory	$                                9,000,000	$                                7,200,000	proposed plan inventory = $9,000,000 x (1-0.20)
Accounts receivable	$                                8,000,000	$                                6,400,000	proposed plan receivable = $8,000,000 x (1-0.20)
payable deferral period	40 days	40 days
Inventory conversion period	138.46 days	123.08 days	Inventory ÷ COGS per day
Average collection period	80 days	71.11 days	Accounts receivable ÷ sales per day
Cash conversion cycle	258.46 days	234.19 days	payable deferrable period + Inventory conversion period + Average collection period

The new proposed policy would reduce the cash conversion cycle by 24 days i.e 258.46 days less 234.19 days