Zervos Inc. had the following data for 2011 (in millions). The new CFO believes (1) that an improved inventory management system could lower the average inventory by $4,000, (2) that improvements in the credit department could reduce receivables by $2,000, and (3) that the purchasing department could negotiate better credit terms and thereby increase accounts payable by $2,000. Furthermore, she thinks that these changes would not affect either sales or the costs of goods sold. If these changes were made, by how many days would the cash conversion cycle be lowered?
A) 34.0
B) 37.4
C) 41.2
D) 45.3
E) 49.8

Question

Quizplus · Accepted Answer

The correct answer is A.The cash conversion cycle (CCC) is the number of days it takes a company to convert its inventory into cash. The CCC is calculated as follows:CCC = (Days Inventory Outstanding + Days Sales Outstanding) - Days Payable OutstandingThe Days Inventory Outstanding (DIO) is the average number of days it takes a company to sell its inventory. The Days Sales Outstanding (DSO) is the average number of days it takes a company to collect its receivables. The Days Payable Outstanding (DPO) is the average number of days it takes a company to pay its suppliers.In this case, the new CFO believes that the following changes would lower the CCC:* An improved inventory management system could lower the average inventory by $4,000.* Improvements in the credit department could reduce receivables by $2,000.* The purchasing department could negotiate better credit terms and thereby increase accounts payable by $2,000.These changes would not affect either sales or the costs of goods sold. Therefore, the CCC would be lowered by the following number of days:DIO = (Average Inventory / Cost of Goods Sold) * 365 daysDIO = ($4,000 / $100,000) * 365 daysDIO = 14.6 daysDSO = (Average Receivables / Sales) * 365 daysDSO = ($2,000 / $50,000) * 365 daysDSO = 14.6 daysDPO = (Average Accounts Payable / Cost of Goods Sold) * 365 daysDPO = ($2,000 / $100,000) * 365 daysDPO = 7.3 daysCCC = (DIO + DSO) - DPOCCC = (14.6 days + 14.6 days) - 7.3 daysCCC = 21.9 daysTherefore, the CCC would be lowered by 21.9 days if the new CFO's changes were made.