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's cash conversion cycle
A) increases by 3 days.
B) decreases by 3 days.
C) will not change.
D) is 93 days.

Question

Quizplus · Accepted Answer

The cash conversion cycle (CCC) represents the time it takes to convert resources invested in inventory and accounts receivable into cash flows from sales. The CCC formula is:
CCC = Inventory Conversion Period + Accounts Receivable Collection Period - Accounts Payable Payment Period

Currently, the firm's CCC is:
CCC = 50 + 43 - 10 = 83 days

If the lockbox system reduces the average collection period by 3 days, then the new collection period is 40 days. Therefore, the new CCC is:
CCC = 50 + 40 - 10 = 80 days

This means the firm's CCC decreases by 3 days, so the best choice is B.

A Firm Has Arranged for a Lockbox System to Reduce