With reference to the goals that management avenues will try to explore, one of their concerns will be the periods of time that they will take in making money literally. This can be noted as an accounting concern that details to the application of the necessary data in attempting to discover and influence the company’s conversion and turnover cycles. Essentially, these cycles are some of the very important metric computations (Bragg, 2010). Likewise, these are based on the questions that management might have on the functionality, performance and the success of the company. It will equally be important to note that in the computations of these metric ratios for operations management, the underlying assumption is one that will always represent the following concerns.
- The period that the company takes to convert its resources into its cash flows
- The period that the company will take in realizing the sale of its currently held turnovers
Fundamentally, these ratios will front the basis of success in computation of some intrinsic management moves such as marketing and the sales movement management. This is fronted as to the reality that these facets of marketing and sales management are what define the time periods that will be used in the conversions and turnover ratios.
Revenues/ sales = $ 20,000,000
Cost of goods sold = 70% 0f sales = 70% of 20,000,000 = (0.7*20,000,000) = $ 14,000,000
Inventories = $ 3,000,000
Accounts payables = $ 2,000,000
Accounts receivables = $ 2,000,000
The company’s cash conversions cycle
Cash conversion cycle = days investor outstanding + days sales outstanding – days payables outstanding
i.e. CCC = DIO + DSO – DPO
Therefore, DIO = average inventory / cost of goods sold per day
DIO = 3,000,000/ (14,000,000/365days)
DIO = 3,000,000/ 38,356 = 78.215
DIO = 78 days.
Computing the DSO = average accounts receivables/ revenues per day
DSO = 2,000,000/ (20,000,000/365 days)
DSO = 2,000,000/ 54,794.52 = 36.5
Therefore, DSO = 37 days
Computing the DPO = Average accounts payable/ cost of goods sold per day
DPO = 2,000,000/ (14,000,000/ 365 days)
DPO = 2,000,000/ 38,356.16 = 52.14
Therefore DPO = 52 days
Equally, computing the CCC = DIO + DSO – DPO
CCC = 78 + 37 – 52
CCC = 63 days.
This is an indication that the company relatively takes about 63 days to convert the purchases on its inventory to receiving cash from these sales considered on credit basis. This averagely computed to a month with 30 days, it will be proper to assume that the company converts purchases to cash in a period of more than two months (63/ 30 =2.1 months)
With the calculations tabled, it will be in order to advocate for an improvement of the company’s CCC, which will be with the concern that the CCC cumulatively almost doubles the DSO. With this concern, it will appear that the management of the sales will take roughly 5.2 weeks (DSO = 37 Days/ 7 days) to make a sale form the held inventories and another 9 weeks (CCC = 63 days/ 7days) to receive these proceeds from the receivables. This period is arguably long; therefore, the company can improve the same with an approach of improving the DOI. This means reducing the days it takes to sell its inventories, the same is achieved by increasing its average inventories, which will increase the sales to bringing down the overall CCC.
Payables deferral period = 40 days
Implying DPO = accounts payable/ cost of goods sold per day = 40 days
Inventory conversion period = 62days
Implying DIO = Average inventory/cost of goods sold per day = 62 days
Collection period = 29 days
Implying DSO = accounts receivables/ revenues per day = 29 days
- Firm’s Cash Conversion Cycle
Cash conversion cycle = Inventory conversion period + average collection period – payables deferral period
CCC = 62 + 29 – 40
CCC = 51 days
- Accounts Receivable Investment
Assuming that all sales are on credit = $ 4,000,000
Computing the accounts receivables investment
DSO = Accounts receivables/ revenues per day
Revenues per day = 4,000,000/ 365 = $ 10,958
Therefore accounts receivables = revenues per day * DSO
Receivables = 10,958 * 29 = $ 317,782.
- How many times a year will the firm turn over its inventory?
Computing the number of times the firm turns over its inventory
Therefore, inventory is turned 13 times
Bragg, M. S., (2010). Business Ratios and Formulas: A comprehensive Guide. New Jersey. John Wiley and Sons.
Tracy, A., (2013). Ratio Analysis Fundamentals: How 17 financial ratios can allow you to analyze any business on the planet. RatioAnalysis.net