Brendan Ltd has annual sales of $200 million with a cost of goods sold of $150 m
ID: 2733922 • Letter: B
Question
Brendan Ltd has annual sales of $200 million with a cost of goods sold of $150 million. They keep an average inventory of $60million. On average, the firm has accounts receivable of $50 million. The firm buys all raw materials on credit, its trade credit terms are net 30 days and it pays on time. The firm’s managers are searching for ways to shorten the cash conversion cycle. If sales can be maintained at existing levels but inventory can be lowered by $15 million and accounts receivable can be lowered by $20 million, what will be the net change in the cash conversion cycle? (Use a 360-day year)
Explanation / Answer
Answer: Cash Conversion Cycle=Days inventory outstanding+Days sales outstanding-Days payable outstanding
=144 days+90 days-30 days
=204 days
Inventory turnover ratio=Net COGS/Average inventory
=$150/$60=2.5 times
Days inventory outstanding=360 days/Inventory turnover ratio
=360 days/2.5=144 days
Receivable Turnover ratio=Net credit sales/Average Receivable
=$200/$50=4 times
Days sales outstanding=360 days/Receivable Turnover ratio
=360 days/4=90 days
When sales can be maintained at existing levels but inventory can be lowered by $15 million and accounts receivable can be lowered by $20 million:
Cash Conversion Cycle=Days inventory outstanding+Days sales outstanding-Days payable outstanding
=108 days+54 days-30 days
=132 days
Inventory turnover ratio=Net COGS/Average inventory
=$150/($60-$15)=3.333 times
Days inventory outstanding=360 days/Inventory turnover ratio
=360 days/3.333=108 days
Receivable Turnover ratio=Net credit sales/Average Receivable
=$200/($50-$20)=6.67 times
Days sales outstanding=360 days/Receivable Turnover ratio
=360 days/6.67=54 days
Net change in the cash conversion cycle=204 days-132 days
=72 days