Question

A firm has arranged for a lockbox system to reduce collection time of accounts receivable. Currently the firm has an average collection period of 43 days, an average age of inventory of 50 days, and an average payment period of 10 days. The lockbox system will reduce the average collection period by 3 days by reducing processing, mail, and clearing float. The firm has total annual outlays of $15,000,000 and currently pays 9 percent for its financing. (Assume a 360-day year.) (a) Calculate the cash conversion cycle before and after the lockbox system. (b) Calculate the savings in financing costs from the lockbox system.

Answer 1

Answer:

The Conversion Cycle Before the Lockbox System is 83 Days

The Conversion Cycle After the Lockbox System is 80 Days

Total Saving Finance Cost = $11,250

Explanation:

Part a)

The Cash Conversion Cycle = Average collection + Average Inventory - Average Payment

The Cash Conversion Cycle = 43 + 50 - 10

The Cash Conversion Cycle = 83 days

Thus, the Conversion Cycle Before the Lockbox System is 83 Days

Although,

After the lockbox system the cash conversion cycle = 83 days - Average Collection by 3 days

After the lockbox system the cash conversion cycle = 80 days

Part b) $The Saving Finance Costs = \frac{Annual Outlays * interest rate * Reduction in Average Collection period}{Total day a year}$

Total Saving Finance Cost = ($15,000,000 × 9% × 3 days) / 360 days

Total Saving Finance Cost = $11,250