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Cash Conversion Cycle Parramore Corp has $12 million of sales, $3 million of inventories, $3.25 million of receivables, and $1.25 million of payables. Its cost of goods sold is 75% of sales, and it finances working capital with bank loans at an 8% rate. What is Parramore’s cash conversion cycle (CCC)? If Parramore could lower its inventories and receivables by 10% each and increase its payables by 10%, all without affecting sales or cost of goods sold, what would be the new CCC, how much cash would be freed up, and how would that affect pretax profits?

Respuesta :

Answer:

1. Cash conversion circle = 122+99 - 51 = 170 days

2. Revised Cash conversion circle = 110+89 - 56 = 143 days

3. The amount of cash to be freed up = (0.1 x $3m) + (0.1 x $3.25) + (0.11 x $1.25) = $762,500

4. Pretax profits will be increased because lower inventory level leads to lower cost of sales and higher gross profit which means higher net profits

Explanation:

Cash conversion Cycle = Days Inventory Outstanding + Days Sales Outstanding - Days Payable Outstanding.

Days Inventory outstanding = Inventory / Cost of Sales x 365 = $3 million / (0.75 x $12 million) x 365 = 122 days

Days Sales outstanding = Account receivable / Sales x 365 = $3.25 million / $12 million x 365 = 99 days

Days Purchases Outstanding = Accounts Payable / Cost of Sales x 365 = $1.25 million /  (0.75 x $12 million) x 365 = 51 days

Therefore Cash conversion circle = 122+99 - 51 = 170 days

2. If Parramore could lower its inventories and receivables by 10% each and increase its payables by 10%, all without affecting sales or cost of goods sold, what would be the new CCC,

Days Inventory outstanding = Inventory / Cost of Sales x 365 = [( 0.9 x $3 million) / (0.75 x $12 million)] x 365 = 110 days

Days Sales outstanding = Account receivable / Sales x 365 = [(0.9 x $3.25 million) / $12 million] x 365 = 89 days

Days Purchases Outstanding = Accounts Payable / Cost of Sales x 365 = [(1.1 x $1.25 million) /  (0.75 x $12 million)] x 365 = 56 days

Therefore revised Cash conversion circle = 110+89 - 56 = 143 days

3. The amount of cash to be freed up = (0.1 x $3m) + (0.1 x $3.25) + (0.11 x $1.25) = $762,500

4. Pretax profits will be increased because lower inventory level leads to lower cost of sales and higher gross profit which means higher net profits

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