The following data is taken from a firm’s income statement: Sales 6,000 Cost of goods sold 4,500 Interest 600 Tax 150 A...
The following data is taken from a firm’s income statement:
Sales 6,000 Cost of goods sold 4,500 Interest 600 Tax 150
And from its balance sheet: Cash 800 Inventory 650 Accounts
receivable 180 Accounts payable 460
(a) Calculate the firm’s cash conversion cycle. Use 365 days per
year.
(b) Is reducing the cash conversion cycle a good objective or not?
Explain.
(c) Can a cash conversion cycle be negative? Explain, and if so,
give an example of a type of firm that would have a negative
cycle.
Homework Answers
(a). Cash conversion cycle = 26.36 days
Explanation;
Cash conversion cycle =
Days inventory outstanding + Days sales outstanding – Days payable outstanding
Days inventory outstanding = $650 * 365 / $4500
= 52.72 days
Days sales outstanding = $180 * 365 / $6000
= 10.95 days
Days payable outstanding = $460 * 365 / $4500
= 37.31 days
Hence, Cash conversion cycle = 52.72 days + 10.95 days – 37.31 days
= 26.36 days
(b).
Reducing the cash conversion cycle a good objective because reduced cash conversion cycle will help a company in realisation of cash much quickely in compare to a company which have longer cash conversion cycle.
That is why it is true that reducing the cash conversion cycle a good objective.
(c).
It is true that a cash conversion cycle can be negative. Negative cash conversion cycle means a company is generating revenue from the customers before this company has to pay its suppliers. Such type of situation result into negative cash conversion cycle.
For example;
Amazon company have negative cash conversion cycle. Apart from this Dell company also showed negative cash conversion cycle in some years.
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