Question

Changing cash conversion cycle Camp Manufacturing turns over its inventory 5 times each year, has an average payment period of 30 days, and has an average collection period of 51 days. The firm has annual sales of $4.0 million and cost of goods sold of $2.2 million. (Use a 365-day year) a. Calculate the firm's operating cycle and cash conversion cycle b. What is the dollar value of inventory held by the firm? c. If the firm could reduce the average age of its inventory from 73 days to 63 days, by how much would it reduce its dollar investment in working capital?

Answer 1

Answer a.

Average Inventory Period = 365 / Inventory Turnover
Average Inventory Period = 365 / 5
Average Inventory Period = 73 days

Operating Cycle = Average Collection Period + Average Inventory Period
Operating Cycle = 51 + 73
Operating Cycle = 124 days

Cash Conversion Cycle = Operating Cycle - Average Payment Period
Cash Conversion Cycle = 124 - 30
Cash Conversion Cycle = 94 days

Answer b.

Inventory Turnover = Cost of Goods Sold / Average Inventory
5 = $2,200,000 / Average Inventory
Average Inventory = $440,000

Answer c.

If average inventory period is 73 days:

Average Inventory Period = 365 * Average Inventory / Cost of Goods Sold
73 = 365 * Average Inventory / $2,200,000
Average Inventory = $440,000

If average inventory period is 63 days:

Average Inventory Period = 365 * Average Inventory / Cost of Goods Sold
63 = 365 * Average Inventory / $2,200,000
Average Inventory = $379,726.03

So, investment in net working capital would decrease by $60,273.97 ($440,000 - $379,726.03)