• Assuming a constant rate for purchases, production, and sales throughout the year, what are Casa de Diseño exists operating cycle (OC), cash conversion cycle (CCC), and resource investment need?
The existing Disenos’ operating cycle (OC)
=average collection period + average age of inventory = (75+ 110) days = 185 days Existing Cash Conversion Cycle (CCC)
= OC - average payment period = (185 – 30) days = 155 days Resources needed
=cost of operating cycle investment ×CCC365= ($ 26,500,000 ×155)/365= $11,253,425
• If Leal can optimize Casa de Diseño’s operations according to industry standards, what will the company’s operating cycle (OC), cash conversion cycle (CCC), and resource investment need to be under these more efficient conditions
Industry Standards on OC = 83 + 75 (days) = 158 days Industry Standard on CCC = (158 – 39) days= 119 days Industry resources needed are then found to be,
=$26,500,000 ×119365 = $8,639,726
• In terms of resource investment requirements, what is the cost of Casa de Diseño’s operational inefficiency?= (Needed resources-Needed industry resources) 0.15
= ( $11,253,425-$8,639,726)0.15 = $2,613,699 ×0.15 = $392,055
• Answer the following:
• If in addition to achieving industry standards for payables and inventory, the firm can reduce the average collection period by offering credit terms of 3/10 net 60, what additional savings in resource investment costs will result for the shortened cash conversion cycle, assuming that the level of sales remains constant?
Average collection could be reduced by 40% and that
Average Collection period = 75 days x (100-40) %= 45 days the operating cycle = (83 + 45) days= 128 days
Hence the cash conversion cycle becomes = (128 – 29) days=89days the value helps us obtain the resources needed as shown below.
=$ 26,500,000 x 89365= $6,461,644 Additional saving = Industry resources needed-the obtained needed resources
= $8,639,726 - $6,461,644
= $2,178,082×15% = $326,712
• If the firm’s sales (all on credit) are $40,000,000 and 45% of the customers are expected to take the cash discount, by how much will the firm’s annual revenues reduce as a result of the discount?Reductions in the annual revenues as a result of the discount will be,= $40,000 x 45% x 3% =$ 540,000.00
• If the firm’s variable cost of $40,000,000 in sales is 80%, determine the reduction in average investment in accounts receivable and the annual savings that will result from this reduced investment, assuming that sales remain constant.We begin by finding the average investment in the relievable accounts receivable with the cash discount
We consider the number of days as,
365/45 = 8.111=$40,000,000 x 80%8.111 =$3,945,205 Average investment in the receivable accounts without cash discount is then found to be (with consideration of number of days as, (365/75) = 4.4867)
=$40,000,000 x 80%4.867 = $ 6,575,342
Hence, the reduction in the investment of the accounts receivable = $6,575,342 - $3,945,205 =$2,630,137
• If the firm’s bad-debt expenses decline from 2% to 1.5% of sales, what annual savings will result, assuming the sales remain constant?
The reduction in the bad-debt expenses will be,
= $40,000,000 ×(0.02 - 0.015)= $ 200,000
• On the basis of your analysis, what recommendations would you offer Teresa Leal?
I will recommend her to offer the cash discount since, it accrues some considerable savings. This is illustrated by the equations explanation below.
= (Annual saving from the reduction in bad ($200,000) + debt expense and in investment on the receivable ($394,521) less the cost of the offering cash discount ($ 540,000).
=($200,000+$394,521)- $500,000 = $ 54,521 which are the savings due to the cash discount.
Bauer, K. (2009, na na). Current Liabilities Management. Retrieved from CAS-IT website: http://lilt.ilstu.edu/kijbaer2/FIL240/downloads/Chapter%252020.ppt
Lawrence J. Gitman, . J. (2011). Principles of Managerial Finance 13th Ed. New Jersey: Peasrson Education.