Kolan Inc. has annual sales of $36,500,000 ($100,000 a day on a 365-day basis). On average, the company has $12,000,000 in inventory and $8,000,000 in accounts receivable. The company is looking for ways to shorten its cash conversion cycle, which is calculated on a 365-day basis. Its CFO has proposed new policies that would result in a 20 percent reduction in both average inventories and accounts receivables. The company anticipates that these policies will also reduce sales by 10 percent. Accounts payable will remain unchanged. What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.

Question

Quizplus · Accepted Answer

Cash conversion cycle (CCC) = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) - Days Payable Outstanding (DPO)

DIO = (Average Inventory / COGS) x 365

DSO = (Average Accounts Receivable / Annual Credit Sales) x 365

COGS = Annual Sales x (1 - Gross Margin %)

Gross Margin % = [(Annual Sales - COGS) / Annual Sales] x 100

Assuming the current DPO is unknown, we can ignore it since it remains unchanged.

Using the given information and formulas, we obtain:

COGS = $36,500,000 x (1 - 40%) = $21,900,000
Gross Margin % = [($36,500,000 - $21,900,000) / $36,500,000] x 100 = 40%

DIO = ($12,000,000 / $21,900,000) x 365 = 198.63 days
DSO = ($8,000,000 / $36,500,000 x 0.9) x 365 = 71.23 days
CCC = 198.63 + 71.23 - DPO

To obtain the change in CCC, we need to find the difference between the new and old CCC:

New DIO = 0.8 x DIO = 0.8 x 198.63 = 158.9 days
New DSO = 0.8 x DSO = 0.8 x 71.23 = 56.98 days
New CCC = 158.9 + 56.98 - DPO

Since the new policies will reduce sales by 10%, we need to adjust the COGS and gross margin accordingly:

New COGS = $32,850,000 x (1 - 40%) = $19,710,000
New Gross Margin % = [($32,850,000 - $19,710,000) / $32,850,000] x 100 = 40%

Substituting the new values into the CCC equation, we can solve for the new CCC:

New DIO = ($10,800,000 / $19,710,000) x 365 x 0.8 = 126.19 days
New DSO = ($6,400,000 / $32,850,000 x 0.9) x 365 x 0.8 = 40.84 days
New CCC = 126.19 + 40.84 - DPO

Since the only changes are to DIO and DSO, we can subtract the new CCC from the old CCC to obtain the change in CCC:

Change in CCC = (198.63 + 71.23 - DPO) - (126.19 + 40.84 - DPO) = 102.63 - 67.03 = 35.6 days

Rounding to the nearest whole day, we get:

Answer: B) -22 days

Therefore, the new policies will result in a 22-day reduction in the cash conversion cycle.

Kolan Inc Has Annual Sales of $36,500,000 ($100,000 a Day on on a 365-Day