Answer:
The Cash Conversion Cycle is the number of days it takes management of a company to convert its inventory into cash on hand after its business transactions. It is a useful metric for measuring the effectiveness of management, especially for companies with inventory of goods for sale.
CCC combines the days of inventory outstanding, accounts receivable outstanding, less accounts payable outstanding to obtain a value based on days.
Therefore, the net change in the Cash Conversion Cycle (CCC) in this scenario is the difference between the previous CCC and the new one based on the new proposals.
a) Days Inventory Outstanding or DIO = Average Inventory divided by Cost of Goods Sold (COGS)per day. Cost of Goods Sold is 85% of sales.
DIO = $15,012,000 / $58,424,750 x 365 days = 94 days
b) Days Sales Outstand or DSO = Average Accounts Receivable divided by Revenue per day.
DSO = $10,008,000 /$68,735,000 x 365 days = 53 days
c) Days Payable Outstanding or DPO = Average Accounts Payable divided by COGS
DPO = 30 days, as given in the question
d) CCC = DIO + DSO - DPO
CCC = 94 + 53 - 30 = 117 days
Based on the new proposals, the CCC is calculated as follows:
a) DIO = $15,012,000 - $1,946,000 / $58,424,750 x 365 days = 82 days
b) DSO = $10,008,000 - $1,946,000 /$68,735,000 x 365 days = 43 days
c) DPO = 40 days as given.
New CCC = 82+43-40 = 85 days.
Therefore, the net change in the cash conversion cycle is 117 - 85 days, i.e. = 32 days.
Explanation:
The CCC has decreased by 32 days in the new scenario. This is an improvement worth pursuing by management.
CCC as a measure of management effectiveness is best obtained for many years in order to compare internally.
Another way it serves as a good measure is to compare the company's CCC with its competitors'.
