ABMF4024 Business Finance Tutorial 8 Answer 23 December 2010

Question 1
The cash conversion cycle is the length of time funds are tied up in working capital, or the length of time
between paying for working capital and collecting cash from the sale of the working capital. Holding other
things constant, if you reduce the CCC you are reducing the amount of funds tied up. These funds have a
cost; therefore, a reduction in funds will lower the firm’s costs and thus raise its profitability. Here we have
made an assumption that you can reduce working capital without harming sales.

Question 2
When most of us use the term cash, we mean currency (paper money and coins) plus bank demand
deposits. However, when corporate treasurers use the term, they often mean currency and demand
deposits plus very safe, highly liquid marketable securities that can be sold quickly at a predictable price and
thus be converted to bank deposits. Therefore, cash as reported on the balance sheets generally includes
short-term securities, which are also called “cash equivalents”.

Question 3
Tools
1) Use a lockbox
2) Insist on wire transfer from customers
3) Synchronize inflows and outflows
4) Use a remote disbursement account
5) Reduce need for “safety stock” of cash
i. Increase forecast accuracy
ii. Hold marketable securities
iii. Negotiable a line of credit
Procedures
1) Forecast cash inflows, outflow, and ending cash
balances
2) Used to plan loans needed or funds available to
invest
3) Can be daily, weekly or monthly forecast
- Monthly for actual planning and daily for actual
cash management

Question 4
Goals of inventory management
1) Reduce inventory cost
2) Make sure u have enough inventory for your company and customer needs
Inventory Control System
1) Just-In-Time System
2) Computerized Inventory System
3) ABC System
4) Outsourcing
ABMF4024 Business Finance Tutorial 8 Answer 23 December 2010

Question 5
Cash ConversionCycle=Inventory conversion period+ Receivables collectoin period + Payablesdefferal period
Inventory Period Receivables Payable
Cash ConversionCycle= + −
Sales per day Sales per day Purchase per day
5,000,000 2,000,000
Cash ConversionCycle= + −30 days
100,000 100,000
Cash Conversion Cycle=50+20−30
Cash ConversionCycle=40 days
Question 6
Sales = $15,000,000; Inventory = $2,000,000; A/R = $3,000,000; A/P = $1,000,000; COGS = 0.8(Sales); Interest
on bank loan = 8%; CCC = ?

CCC = Inventory conversion period + Average collection period – Payables deferral period.

Inventory
Inventory conversion period = Cost of goods sold per day
$ 2, 000 , 000
= [(0 .8 )($ 15 ,000 , 000 )]/365
$2 ,000,000
= $32 ,876.7123
= 60.83 days.
Receivables
Average collection period = Sales/365
$ 3,000 ,000
= $15 ,000,000/365
= 73 days.
Payables
Payables deferral period = Cost of goods sold/365
$1 ,000,000
= $32 ,876.7123
= 30.42 days.

CCC = 60.83 + 73 – 30.42 = 103.41 days.

2. Lower inventories and receivables by 10% each and increase payables by 10%. Sales and COGS
remain the same.
Inventory = $2,000,000  0.9 = $1,800,000.
A/R = $3,000,000  0.9 = $2,700,000.
A/P = $1,000,000  1.1 = $1,100,000.
Calculate new CCC:
$1 ,800,000
Inventory conversion period = $32 ,876.7123
= 54.75 days.
ABMF4024 Business Finance Tutorial 8 Answer 23 December 2010

$2,700,000
Average collection period = $15 ,000,000/365
= 65.70 days.

$1 ,100,000
Payables deferral period = $32 ,876.7123
= 33.46 days.

New CCC = 54.75 + 65.70 – 33.46 = 86.99 days ≈ 87 days.

Question 7
Annual sales – RM50, 735,000
Inventory level – RM15, 012,000
Account receivable balance outstanding – RM10, 008,000
Payable deferral period – 30days

Cash ConversionCycle=Inventory conversion period+ Receivables collectoin period + Payables defferal period
Inventory Period Receivables
Cash ConversionCycle= + −30 days
Annual COGS /365 Annual Sales/365
15,012,000 10,008,000
Cash ConversionCycle= + −30 days
139,000 139,000
Cash ConversionCycle=108+72−30
Cash ConversionCycle=150 days

Annual sales – RM50,735,000

Inventory level – RM13,066,000 After lowered inventory and a/c
Account receivable balance outstanding – RM8,062,000 receivable by RM1,946,000

Payable deferral period – 40days

Inventory Period Receivables

Cash ConversionCycle= + −40 days
Annual COGS /365 Annual Sales/365
13,066,000 8,062,000
Cash ConversionCycle= + −40 days
139,000 139,000
Cash ConversionCycle=94 +58−40
Cash ConversionCycle=112 days

New CCC – Old CCC = 112 – 150 = -38days

*Better because lower CCC, very fast to pay suppliers
ABMF4024 Business Finance Tutorial 8 Answer 23 December 2010
ABMF4024 Business Finance Tutorial 8 Answer 23 December 2010

Question 8
Cash ConversionCycle=Inventory conversion period+ Receivables collectoin period + Payablesdefferal period
CCC ICP RCP PDP
(shorten) (shorten) (shorten) (longer)
Length of time receives and How long you take to Time required to convert Payment of cash
makes payment when convert good to sell it receivable to cash
receive cash inflow *choose customers of 5 “c”
i. Character of customer
ii. Capacity
iii. Capital
iv. Collect oral
v. Condition of customer

 In order to have shorter time frame CCC, RCP shorten, PDP longer, LCP shorten.

Question 9
The maturity matching, or “self-liquidating,” approach calls for matching asset and liability maturities. All of
the fixed assets plus the permanent current assets are financed with long-term capital, but temporary
current assets are financed with short-term debt. A more aggressive financing approach would involve
financing some of its permanent assets with short-term debt. The reason for adopting the aggressive policy
is to take advantage of the fact that the yield curve is generally upward sloping, hence short-term interest
rates are generally lower than long-term rates. A more conservative financing approach would involve
financing all permanent current assets as well as some of its seasonal needs with long-term capital. In this
situation, the firm uses a small amount of short-term credit to meet its peak requirements, but it also meets
a part of its seasonal needs by storing liquidity in the form of marketable securities. This is a very safe,
conservative financing policy.

The aggressive approach is the riskiest of all three approaches because if the firm encountered temporary
financial problems, the lender might not renew its loan. However, because the yield curve is normally
upward sloping, short-term interest rates are lower than long-term rates, thus would lead to higher profits.
The conservative approach is the least risky but it is also the least profitable of the three approaches. The
maturity matching approach is between these two approaches in both risk and profitability. Optimistic
and/or aggressive managers will probably lean more toward short-term credit to gain an interest cost
advantage, while more conservative managers will lean toward long-term financing to avoid potential
renewal problems.