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Margetis Inc
Margetis Inc. carries an average inventory of $750,000. Its annual sales are $10 million, its cost of goods sold is 75% of annual sales, and its average collection period is twice as long as its inventory conversion period. The firm buys on terms of net 30 days, and it pays on time. Its new CFO wants to decrease the cash conversion cycle by 10 days, based on a 365-day year. He believes he can reduce the average inventory to $647,260 with no effect on sales. By how much must the firm also reduce its accounts receivable to meet its goal in the reduction of the cash conversion cycle?
Expert Solution
Cost of goods sold = 75% *($10,000,000)
= $7,500,000
Inventory turnover ratio = Cost of goods sold / Average inventory
= $7,500,000 / $750,000
= 10 times
Days sales inventory = 365 / Inventory turnover ratio
= 365/ 10
= 36.5 days
Average collection period = 2 *(36.5 days)
= 73 days
Average collection period = (Accounts receivables * 365) / Credit sales
73days = (AR * 365) / $10,000,000
$730,000,000 = AR * 365
AR = $2,000,000
Cash conversion cycle = DSO + DIO - DPO
here,
DSO = Days sales outstanding
DIO = Days inventory outstanding
DPO = Days payable outstanding
Cash conversion cycle = 73 days + 36.5 days - 30days
= 79.5 days
Days inventory outstanding = (365 / Inventory turnover)
= 365 / (Cost of goods sold / Average inventory)
= 365 / ($7,500,000 / $647,260)
= 365 / 11.59
= 31.5 days
DSO =(Accounts receivables * 365) / Credit sales
68 = (AR * 365) / $10,000,000
$680,000,000 = AR * 365
AR= $680,000,000 / 365
= $1,863,014
So,
Accounts receivable reduced by =$2,000,000 - $1,863,014
= $136,986
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