Zervos Inc. had the following data for 2008 (in millions). The new CFO believes

Question

Zervos Inc. had the following data for 2008 (in millions). The new CFO believes (a) that an improved inventory management system could lower the average inventory by $4,000, (b) that improvements in the credit department could reduce receivables by $2,000, and (c) that the purchasing department could negotiate better credit terms and thereby increase accounts payable by $2,000. Furthermore, she thinks that these changes would not affect either sales or the costs of goods sold. If these changes were made, by how many days would the cash conversion cycle be lowered?

Explanation / Answer

The formula for calculating the Cash conversion cycle is CCC = DIO + DSO - DPO Where DIO represents Days inventory Outstanding DSO represents Days Sales Outstanding DPO represents Days Payable outstanding Cash conversion cycle impact by inventory reduction DIO = (Average inventory / Cost of goods sold) * 365 Original DIO = ($20,000/$80,000) *365 =91.25 days Revised DIO= ($16,000/$80,000 *365) = 73 days Cash conversion cycle impact by reduced accounts receivable DPO = (Accounts payable / Cost of goods sold) * 365 Original DPO =($10,000/$80,000)*365 = 45.625 days Revised DPO = ($12,000/$80,000) *365 = 54.75 days Cash conversion cycle impact by increased a/c payable DSO = (Total receivables / Total credit sales) * 365 Original DSO = ($16,000/$110,000 *365) = 53.09 days Revised DSO = ($14,000/$110,000 *365) = 46.45 days CCC = DIO + DSO – DPO Original CCC = 91.25 + 53.09 – 45.63 = 98.71 days Revised CCC = 73 + 46.45 – 54.75 = 64.7 days Total impact = original CCC – Revised CCC = 98.71 – 64.7 = 34.01 days So, cash conversion cycle will be lowered by 34.0 days

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