2.
Cash conversion cycle
Cash management is a very important function of managers. Companies need to manage their
operations in a way that they can sustain growth and yet not run out of cash.
Consider the case of the Purple Panda Importers Corporation:
Purple Panda Importers Corporation has forecasted sales of $29,000,000 for next year and
expects its cost of goods sold (COGS) to remain at 80% of sales. Currently, the firm holds
$2,900,000 in inventories, $1,800,000 in accounts receivable, and $2,400,000 in accounts
payable.
Approximately how long does it take Purple Panda Importers to convert its raw materials to its
finished products and then to sell those goods? (Note: In all calculations, assume that there are
365 days in a year.)
38.79 days
41.07 days
36.50 days
45.63 days
Points:
1/1
Close Explanation
Explanation:
The inventory conversion period is the average length of time it takes to convert raw materials
to their finished products and then to sell them. To find the inventory conversion period, divide
the firm’s inventory balance by its average daily COGS. You are not directly given the COGS;
however, you know that the COGS will be 80% of the firm’s $29,000,000 in sales. The COGS
can be calculated as follows:
Annu $29,000,000 x $23,200,000
al 0.80 .00
COGS
Now that you have found Purple Panda Importers’s annual COGS, you can solve for the
inventory conversion period.
Make sure that you divide the annual COGS by 365 days to find the average daily COGS. Then
divide $2,900,000 in inventory by the average daily COGS. That is:
Inventories
Average Daily COGS
Inventory Conversion =
Period Inventories
(Annual COGS/365 days)
Inventory Conversion
InventoriesAverage Daily
Period
COGS=InventoriesAnnual COGS/365
days
$2,900,000
($23,200,000.00/365 days)
=
$2,900,000
$63,561.64
$2,900,000$23,200,000.00/365
days=$2,900,000$63,561.64
45.63 days
45.63 days
On average, it takes Purple Panda Importers 45.63 days to acquire raw materials, convert
them to finished products, and then sell them to customers.
On average, it takes 22.66 days from the time a sale is made until the time cash is collected
from customers.
Points:
1/1
Close Explanation
Explanation:
The average collection period, also called the days sales outstanding, is the length of time it
takes for the firm to collect cash on sales made.
To find the average collection period, divide the firm’s accounts receivable balance by its
average daily sales as follows:
Accounts Receivable
Average Daily Sales
Average Collection =
Accounts Receivable
Period (Sales/365 days)
Average Collection Period Accounts ReceivableAverage Daily
Sales=Accounts ReceivableSales/365
days
$1,800,000
($29,000,000/365 days)
=
$1,800,000
$79,452.05
$1,800,000$29,000,000/365
days=$1,800,000$79,452.05
22.66 days
22.66 days
On average, it takes Purple Panda Importers 22.66 days to collect cash from customers after a
sale is made. However, note that not all sales are made on credit; many customers pay cash
immediately. Some analysts prefer to calculate the average collection period using only sales
made on credit rather than total sales.
Purple Panda Importers relies on customer credit when it buys raw materials from its suppliers. On
average, it takes 37.76 days after the firm purchases materials before it sends cash to its
suppliers.
Points:
1/1
Close Explanation
Explanation:
The payables deferral period is the average length of time between the purchase of raw
materials and the payment of cash for the materials. To find the payables deferral period,
divide the firm’s accounts payable balance by its average daily COGS. You are not directly
given the COGS; however, you know that the COGS will be 80% of $29,000,000 in sales. The
COGS can be calculated as follows:
Annual $29,000,000 x
COGS 0.80
$23,200,000.00
Now that you have found the COGS, you can calculate the payables deferral period as follows:
Accounts Payable
Average Daily COGS
Payables Deferral =
Accounts Payable
Period (COGS/365 days)
Payables Deferral Period Accounts PayableAverage Daily
COGS=Accounts Payable(COGS/365
days)
$2,400,000
($23,200,000.00/365 days)
=
$2,400,000
$63,561.64
$2,400,000($23,200,000.00/365
days)=$2,400,000$63,561.64
37.76 days
37.76 days
On average, it takes Purple Panda Importers 37.76 days to pay its suppliers cash for the
materials that it buys. The firm’s payables deferral period is considerably longer than its
average collection period, which suggests that the firm is either chronically late in paying
suppliers or that it can get better terms from its suppliers than it is willing to extend to its
customers.
