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1 of 5 15model 10/6/2009 8:16 1/13/2003 Chapter 15. Model for managing current assets This chapter deals with working capital management. Two useful tools for working capital management are (1) the cash conversion cycle and (2) the cash budget. This spreadsheet model shows how these tools are used to help manage current assets. THE CASH CONVERSION CYCLE The cash conversion cycle model focuses on the length of time between when the company must make payments and when it receives cash inflows. The cash conversion cycle is determined by three factors: (1) The inventory conversion period, which is the average time required to convert materials into finished goods and then to sell those goods. The inventory conversion period is measured by dividing inventory by the average daily sales. (2) The receivables collection period, which is the length of time required to convert the firm's receivables into cash, or how long it takes to collect cash from a sale. The receivables collection period is measured by the days sales outstanding ratio (DSO), which is accounts receivable divided by average daily sales. (3) The payables deferral period, which is the average length of time between the purchase of materials and labor and payment for them. The payable deferral period is calculated by dividing average accounts payable by purchases per day (cost of goods sold divided by 360 or 365 days). The cash conversion cycle is determined by the following formula: Cash conversion cycle = Inventory conversion period + - Problem Calculate the cash conversion cycle for the Real Time Computer Company. Annual sales are \$10 million, and the annual cost of goods sold is \$8 million. The average levels of inventory, receivables, and accounts payable are \$2,000,000, \$657,534, and \$657,534, respectively. RTCC uses a 365-day accounting year. Sales \$10,000,000 COGS \$8,000,000 Inventories \$2,000,000 AR \$657,534 AP \$657,534 Days/year 365 Receivables collection period Payables deferral period A B C D E F G H I J K 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37

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## This note was uploaded on 05/31/2009 for the course MBA 4500 taught by Professor Eyupcetin during the Spring '09 term at Istanbul Technical University.

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