Answer to Question #10351 in Economics of Enterprise for tracy brown

Question

Your consulting firm was recently hired to improve the performance of Shin-Soenen Inc, which is highly profitable but has been experiencing cash shortages due to its high growth rate. As one part of your analysis, you want to determine the firm’s cash conversion cycle. Using the following information and a 365-day year, what is the firm’s present cash conversion cycle?

Answer 1

The cash conversion cycle is one of the most important metrics that a business owner should calculate when conducting a cash flow analysis of a
company. It expresses the length of time, in days, that it takes for a company
to convert resource inputs into cash flows. Cash conversion cycles for small
businesses are predicated on four central factors:
1) the number of days it takes customers to pay what they owe;
2) the number of days it takes the business to make its product (or complete its service);
3) the number of days the product (or service) sits in inventory before it is sold;
4) the length of time that the small business has to pay its vendors.
The following formulas may be used to determine these factors:
Accounts receivable days - divide the receivables balance by the last 12 months' sales, then multiply the result by 365 (the number of days in a year).
Inventory days - take the inventory balance, divide it by the last 12 months' cost of goods sold, and then multiply the result by 365.
Accounts payable days - take the company's payables balance, divide it by the last 12 months' cost of goods sold, and then multiply the resulting figure
by 365.Average inventory = $75,000
Annual sales = $600,000
Annual cost of goods sold = $360,000
Average accounts receivable = $160,000
Average accounts payable = $25,000

Cash conversion cycle =Average inventory/(Annual cost of goods sold:365)+Average
accounts receivable/(Annual sales:365)-Average accounts payable/(Annual sales:365) = 75,000/(360,000:365)+160,000/(600,000:365)-25,000/(600,000:365) = 148 days.