Question #10351

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?

Expert's answer

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.

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.

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