Margetis Inc.carries an average inventory of $750,000.Its annual sales are $10 million,its cost of goods sold are 75% of annual sales,and its receivables collection period is twice as long as its inventory conversion period.The firm buys on terms of net 30 days,and it pays on time.Its new CFO wants to decrease the cash conversion cycle by 18 days,based on a 365-day year.He believes he can reduce the average inventory to $605,885 with no effect on sales.By how much must the firm also reduce its accounts receivable to meet its goal in the reduction of its cash conversion cycle?

Question

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The correct answer is A.The cash conversion cycle (CCC) is the time it takes for a company to convert its inventory into cash. It is calculated as follows:CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) - Days Payable Outstanding (DPO)DIO is the number of days it takes for a company to sell its inventory. It is calculated as follows:DIO = (Average Inventory / Cost of Goods Sold) * 365DSO is the number of days it takes for a company to collect its receivables. It is calculated as follows:DSO = (Average Accounts Receivable / Annual Sales) * 365DPO is the number of days it takes for a company to pay its suppliers. It is calculated as follows:DPO = (Average Accounts Payable / Cost of Goods Sold) * 365In this case, Margetis Inc. has an average inventory of $750,000, annual sales of $10 million, and a cost of goods sold of 75% of annual sales. This means that DIO is 30 days. The firm's receivables collection period is twice as long as its inventory conversion period, so DSO is 60 days. The firm buys on terms of net 30 days, so DPO is 30 days.The firm's CCC is therefore 60 days. The new CFO wants to decrease the CCC by 18 days, so the new CCC will be 42 days.The firm can reduce its DIO by reducing its average inventory. The new CFO believes that he can reduce the average inventory to $605,885 with no effect on sales. This will reduce DIO to 24 days.The firm can also reduce its DSO by reducing its average accounts receivable. To reduce the CCC by 18 days, the firm must reduce its DSO by 18 days. This will reduce DSO to 42 days.The firm's average accounts receivable is equal to DSO * Annual Sales / 365. To reduce DSO to 42 days, the firm must reduce its average accounts receivable by $300,997.