In the early 1990s, Cranston Dispensers, Inc. was quick to realize that concern
ID: 2424668 • Letter: I
Question
In the early 1990s, Cranston Dispensers, Inc. was quick to realize that concern for the environment would cause many consumer product manufacturers to move away from aerosol dispensers to mechanical alternatives that pose no threat to the ozone layer. In the following decades, most countries banned the most popular aerosol propellants, first chlorofluorocarbons and then hydrocholrofluorocarbons. As the leading manufacturer of specialized pump and spray containers for a variety of products in cosmetics, household cleaning supplies, and pharmaceutical industries, Cranston experienced a rapid increase in sales and profitability after it made this strategic move. At that time, the firm focused much of its attention on capturing market share and keeping up with demand.
For most of 20x4 and 20x5, however, Cranston’s share price was falling while shares of other companies in the industry were rising. At the end of fiscal 20x5, the company hired Susan McNulty as the new treasurer, with the expectation that she would diagnose Cranston’s problems and improve the company’s financial performance relative to that of its competitors. She decided to begin the task with a thorough review of the company’s working capital management practices.
While examining the company’s financial statements, she noted that Cranston had a higher percentage of current assets on its balance sheet than other companies in the packaging industry. The high level of current assets caused the company to carry more short-term debt and to have higher interest expense than its competitors. It was also causing the company to lag behind its competitors on some key financial measures, such as return on assets and return on equity.
In an effort to improve Cranston’s overall performance, Susan has decided to conduct a comprehensive review of working capital management policies, including those related to the cash conversion cycle, credit policy, and inventory management. Cranston’s financial statements for the three most recent years follow.
Cranston Dispensers
Income Statement
($ in thousands)
Account
20x5
20x4
20x3
Sales
3,784
3,202
2,760
Cost of Goods Sold
2,568
2,172
1,856
Gross Profit
1,216
1,030
904
Selling & Administrative
550
478
406
Depreciation
247
230
200
Earnings Before Interest and Taxes
419
322
298
Interest Expense
20
25
14
Taxable Income
399
297
284
Taxes
120
89
85
Net Income
279
208
199
Cranston Dispensers
Balance Sheet
($ in thousands)
Account
20x5
20x4
20x3
Current Assets
Cash
341
276
236
Accounts Receivable
722
642
320
Inventory
595
512
388
Total Current Assets
1,658
1,430
944
Net Fixed Assets
1,822
1,691
1,572
Total Assets
3,480
3,121
2,516
Current Liabilities
Accounts Payable
332
288
204
Accrued Expenses
343
335
192
Short-term Notes
503
491
243
Total Current Liabilities
1,178
1,114
639
Long-term Debt
398
324
289
Other Long-term Liabilities
239
154
147
Total Liabilities
1,815
1,592
1,075
Owners’ Equity
Common Equity
1,665
1,529
1,441
Total Liabilities & Equity
3,480
3,121
2,516
Question:
Suppose Cranston institutes a policy of granting a 1% discount for payment within fifteen days with the full amount due in 45 days. Half the customers take the discount, the other half take an average of sixty days to pay.
What is the length of Cranston’s collection cycle under this new policy?
In dollars, how much would the policy have cost Cranston in 20x5?
If this policy had been in effect during 20x5, by how many days would Cranston have shortened the cash conversion cycle?
Account
20x5
20x4
20x3
Sales
3,784
3,202
2,760
Cost of Goods Sold
2,568
2,172
1,856
Gross Profit
1,216
1,030
904
Selling & Administrative
550
478
406
Depreciation
247
230
200
Earnings Before Interest and Taxes
419
322
298
Interest Expense
20
25
14
Taxable Income
399
297
284
Taxes
120
89
85
Net Income
279
208
199
Explanation / Answer
Ans 1 New Collection Cycle 15 days/2+60 days/2 47.5 days Ans 2 Cranston will lose 1% on half of the sales as 50% customers opt for this Amount in $ thosands $3784/2*0.01 18.92 before tax Taxable Income before the above adjustment 399 Taxes 120 So tax rate 120/399*100 30.07518797 Tax benefit on dicount= 18.92*.3 5.676 Cost after tax 13.244 Ans 3 Cash Conversion cycle in 2005= 3784/((722+642)/2)/365 5.55 365/5.55 65.77 days now the new policu=y will shortened the collection period 65.77-47.5 18.27 days