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Whitson Co. is looking for ways to shorten its cash conversion cycle. It has annual sales of $36,500,000, or $100,000 a day on a 365-day basis. The firm's cost of goods sold is 75% of sales. On average, the company has $9,000,000 in inventory and $8,000,000 in accounts receivable. Its CFO has proposed new policies that would result in a 20% reduction in both average inventories and accounts receivable. She also anticipates that these policies would reduce sales by 10%, while the payables deferral period would remain unchanged at 35 days. What effect would these policies have on the company's cash conversion cycle? Round to the nearest whole day.

Answer :

Answer:

A reduction in the Cash Conversion cycle by 22 days

Explanation:

The question is determine the effect of Whitson Co's policy on the comopany's cash conversion cycle as follows:

Description                                 Original                             New

Annual Sales                          3,650,000                          3,285,000 (There is 10% reduction in sales)

Day in Year                                   365                                         365

Sales per day                             100,000                               90,000

Cost of Goods Sold/ Sales              75%                                  75%

Cost of Goods Sold/ Day              75,000                              67,500

Inventory                                    9000,000                             7200,000 (20% reduction)              

Accounts Receivable              8000,000                              6400,000  (20% reduction in receivables)

Pay deferral period                       35                                       35

Step 2) Calculate the inventory conversion period = Average inventory/ Cost of Goods per day

Old = 900000/75000 = 120

New = 7,200,000/67,500 = 106.67

Step 3) Average collection Period

=Number of working days/ debtors turnover ratio

Old = Accounts receivable/ (sales/365) = $80

New = 6,400,000 / (32,850,000/365)= 71.111

Finally, the Cash Conversion cycle = Inventory conversion period + Average Collection Period - Pay Deferral period

CCC for the Original/old = 120+80 -35 = 165

CCC for the new = 106.67 +71.11-35=142.78

Effect of the policy is as follows

= CCC new- CCC old=  146.78 - 165 = -22.22days

A reduction in the Cash Conversion cycle by 22 days

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