How high can accounts receivable be allowed to grow before the firm's receivables period exceeds 50 days if annual sales equal $5 million and the cash conversion cycle equals 75 days?

Question

Quizplus · Accepted Answer

First, we need to determine the current level of accounts receivable using the cash conversion cycle formula:

Cash conversion cycle = Days inventory outstanding + Days sales outstanding - Days payable outstanding 
75 = DIO + DSO - DPO

Since we do not have any information about the inventory period or payable period, we can assume that they remain constant and eliminate them from the formula:

DSO = 75

Next, we can calculate the current level of accounts receivable using the following formula:

Accounts receivable = (DSO / 365) x Annual sales

Accounts receivable = (75 / 365) x $5,000,000 
Accounts receivable = $1,032,877

To avoid exceeding a 50-day receivables period, we need to calculate the maximum allowable level of accounts receivable using the following formula:

Max accounts receivable = (50 / 365) x Annual sales

Max accounts receivable = (50 / 365) x $5,000,000 
Max accounts receivable = $684,931.51

Therefore, the answer is B.

How High Can Accounts Receivable Be Allowed to Grow Before