You were recently hired as CFO to improve the performance of Dennis Systems, whi
ID: 2642953 • Letter: Y
Question
You were recently hired as CFO to improve the performance of Dennis Systems, which is highly profitable but has been experiencing cash shortages due to its high rate of growth. As one part of your analysis, you want to determine the firm's cash conversion cycle. Using the following information and a 365-day year, what is your estimate of the firm's present cash conversion cycle?
Average inventory: $120,000
Annual sales: $600,000
Average accounts receivable: $160,000
Average accounts payable: $25,000
Total annual purchases: $365,000
Buy on net 30 days, no discounts: 30
Sell on net 50 days, no discounts: 50
Explanation / Answer
Cash conversion cycle = AAI + ACP - APP
(1) AAI = Average age of inventory
AAI = Average Inventory / cost of sales per day
Cost of sales per day = Opeing Inventory + Purchase - Closing Inventory / 365
We have information of only average inventory of $120,000 hence we will assume that opeing and closing inventory should be same i.e $120,00, Now we can calculate cost of sales per day with the above formula:
Cost of sales per day = $120,000+ $365,000 - $120,000 / 365 = $1,000 per day
AAI = Average Inventory / Cost of sales per day = $120,000 / $1,000 = 120 Days
(2) ACP = Average collection period
ACP = Average receivalbe / Sales per day
Sales per day = $600,000/ 365 = $1,643.84
ACP = $160,000 / $1,644 = 97 Days
(3) APP = Average payment period
= Average payable / cost of sales per day
= $25,000 / $1,000
APP = 25 Days
Now we can calculate Cash conversion cycle = AAI + ACP - APP
= 120 +97-25
CCC = 192 Days
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