American Products is concerned about managing cash efficiently. On the average,

Question

American Products is concerned about managing cash efficiently. On the average, inventories have an age of 90 days, and accounts receivable are collected in 60 days. Accounts payable are paid approximately 30 days after they arise. The firm has annual sales of about $30 million. Cost of goods sold are $20 million, and purchases are $15 million. (a) Calculate the firm's operating cycle. (b) Calculate the firm's cash conversion cycle. (c) Calculate the amount of resources needed to support the firm's cash conversion cycle. (d) Discuss how management might be able to reduce the cash conversion cycle.

Show all formulas used to calculate the answers above.

Explanation / Answer

a.Operating Cycle = Inventory Holding Period + Receivable Collection Period

operating cycle= 90+60=150

b.Cash Operating Cycle = Inventory Holding Period + Receivable Collection Period – Creditor’s Payment Period

cash operating cycle=90+60-30=120days

c.Amount of resources needed to support firms cash conversion cycle

   Resources needed = (total annual outlays ÷ 365 days) × CCC

Resources needed = (total annual outlays ÷ 365 days) × CCC = [$30,000,000 ÷ 365] × 120 = $9,863,013.70

(d) Shortening either the average age of inventory or the average collection period, lengthening the average payment period, or a combination of these can reduce the cash conversion cycle.

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