FM12 Ch 22 Tool Kit - A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15...

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1 of 14 1/12/2007 Chapter 22. Model for Working Capital Management = + - Problem Sales $10,000,000 COGS $8,000,000 Inventories $2,000,000 AR $657,534 AP $657,534 Days/year 365 Cash conversion cycle (CCC) = Inventory conversion period + - = Inventory/Sales per day + AR/Sales per day - AP/COGS per day = 73.00 + 24.00 - 30.00 = 67.00 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 (Section 22.1) 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 Receivables collection period Payables deferral period 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. 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 38 39 40
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2 of 14 Improvement in the Cash Conversion Cycle Original Improved Annual sales $10,000,000 10,000,000 Costs of goods sold (COGS) 8,000,000 8,000,000 Inventory conversion period (days) 73 65 Receivables collection period (days) 24 23 Payable deferral period (days) 30 31 Cash conversion cycle (days) 67 57 $2,000,000 $1,780,822 657,534 630,137 657,534 679,452 Net operating working capital (NOWC) $2,000,000 $1,731,507 Improvement in FCF = Original NOWC - Improved NOWC $268,493 Input Data Collections during month of sale 20% Assumed constant. Don't change. Collections during 1st month after sale 70% Formula. Don't change. Collections during 2nd month after sale 10% Allow this value to change to reflect slower collections. Discount on first month collections 2% Purchases as a % of next month's sales 70% Lease payments $15 Construction cost for new plant (Oct) 100 Target cash balance $10 Sales adjustment factor 0.00 It takes 73 days to make and then sell a computer, and another 24 days to collect cash after the sale, or a total of 97 days between spending money and collecting cash.
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FM12 Ch 22 Tool Kit - A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15...

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