Consider the case of a company's financial statements last year. The company had annual sales of $9,500,000, cost of goods sold of $6,175,000, inventory of $3,200,000, accounts receivable of $2,100,000, and accounts payable of $2,500,000.
Slack Shoe Broadcasting Company is interested in determining the length of time funds are tied up in working capital. Use the information in the preceding table to complete the following table. (Note: Use 365 days as the length of a year in all calculations, and round all values to two decimal places.)
Value
Inventory Conversion Period
Average Collection Period
Payables Deferral Period
Cash Conversion Cycle
Both the inventory conversion period and payables deferral period use the average day COGS (Cost of Goods Sold) in their denominators, whereas the average collection period uses average daily sales in its denominator. Why do these measures use different inputs? Inventory and accounts payable are carried at cost on the balance sheet, whereas accounts receivable are recorded at the price at which goods are sold. Current assets should be divided by sales, but current liabilities should be divided by the COGS.
Is there generally a positive or negative relationship between net working capital and the cash conversion cycle?
The management at Black Sheep Broadcasting Company wants to continue its internal discussion related to cash management. One of the finance team members presents the following case to his cohorts:
Which of the following responses to the CFO's statement is most accurate? - The CFO is not taking into account the amount of time the company has to pay its suppliers. Generally, there is a certain length of time between the purchase of materials and labor and the payment of cash for them. The CFO's cash reduction strategy may not be feasible.
Case in Discussion:
Happy Turtle Transporters' management plans to finance its operations with a loan that will be repaid as soon as it is available. The company's management expects that it will take 40 days to manufacture and sell its products and 35 days to collect payment from customers. Happy Turtle's CFO has told the rest of the team that they can reduce the cash conversion cycle by implementing certain strategies.
