Parramore Corp has $13 million of sales, $3 million of inventories, $4 million of receivables, and $2 million of payables. Its cost of goods sold is 75% of sales, and it finances working capital with bank loans at an 8% rate. Assume 365 days in year for your calculations.
Answer 1: Cash conversion cycle = DIO + DSO – DPO
DIO = Days Inventory Outstanding = (Average Inventory / Cost of goods sold)*365 = $3 Million / ($13 Million *75%) *365 = 112.3077 days
DSO = Days Sales Outstanding = (Average Accounts Receivables / Total Credit sales)*365 = ($4 Million / $ 13 Million) *365 = 112. 3077 days
DPO = Days Payable Outstanding = (Average Accounts Payable / Cost of goods sold)*365 = $ 2 Million / ($13 Million *75%) *365 = 74.8718 days
Cash conversion cycle = 112.3077+112.3077-74.8718 = 149.74 Days
Answer 2: If inventories and receivables lowered and accounts payable increase by 11% then new figures will be:
Inventories = $ 3 Million *(1-.11) = 2.67 Million
Accounts receivables = $ 4 Million * (1-0.11) = 3.56 Million
Accounts payable = $ 2 Millions * (1+0.11) = 2.22 Million
Sales = $13 Million (same)
COGS = $ 13 Million *75% = 9.75 Million (same)
DIO = 2.67 Million / 9.75 Million = 99.95384615 Days
DSO = 3.56 Million / 13 Million = 99.95384615 Days
DPO = 2.22 Million / 9.75 Million = 83.10769231 Days
NEW cash conversion cycle = 99.95384615+99.95384615-83.10769231 = 116.80 Days
Answer 3:
Cash /investment being ideal in normal position = 3+4-2 = 5 Million
Cash /investment being ideal in new scenario = 2.67+3.56-2.22 = 4.01Million
So cash freed = 5 Million – 4.01 Million = 0.99 Million = 990,000
Let understand this further
Particulars |
Old Position |
New Position |
Cash freed |
Cash Converted from inventories |
3 |
2.67 |
0.33 |
Cash Collected from Receivables |
4 |
3.56 |
0.44 |
Cash not paid to suppliers |
2 |
2.22 |
0.22 |
0.99 |
Answer 4:
Impact on profit:
Since we know that 990,000 cash will be freed if the given situation is implied, so there will be saving of interest @ 8% on 990,000
Reduction in interest cost = Increase in profit = 990,000*8% = 79,200
Parramore Corp has $13 million of sales, $3 million of inventories, $4 million of receivables, an...