Cash Conversion Cycle

CFA Level I
#1

Can anyone explain me why (at least it seems what this question is doing) you use ending values when computing number of days and average of beggining and ending when its turnover, it’s just not the same thing converted in days?

  1. Given the following financial statement data, calculate the net operating cycle for this company. In Millions ($) Credit sales 40,000 Cost of goods sold 30,000 Accounts receivable 3,000 Inventory—Beginning balance 1,500 Inventory—Ending balance 2,000 Accounts payable 4,000 The net operating cycle of this company is closest to:
  2. 3.8 days.
  3. 24.3 days.
  4. 51.7 days.
#2

I get A.

You can only do with what the problem gives you. If you can calculate average denominators for the turnover ratios, use it. They gave you the beginning and ending inventory so that you can calculate purchases. I can’t get any possible answer using average inventory or using COGS in place of purchases to calculate days payable. Since everything else is calculated using ending values, my educated guess is that they wanted you to be consistent.

#3

Firstly, you have to determine your purchases since you were given COGS,Opening Inventory and Closing Inventory as follows:

Opening Inventory + Purchases - Closing Inventory = COGS

Solving for purchases mathematically, we would have the following equation:

COGS + Closing Inventory - Opening Inventory = Purchases

Input the given values in the equation, Purchases will 30,500

Then solve for Receivable outstanding/collection period, Payable outstanding/payment period and Days Outstanding on Inventoryusing their formulas.

Recivables Outstanding period = 3,000/40,000 * 365 days = 27.375days

Payable Outstanding period = 4,000/30,500 * 365 days = 47.8689days

Inventory Turnover = 30,000/1,750 = 17x; Outstanding days on Inventory = 365days/17x = 21days

Therefore; Net Operating cycle/Cash Conversion cycle = 27.375days + 21days - 47.8689days = 0.50days.

The answer is not in the given question.

#4

But, it is given. As mentioned by another poster, it wouldn’t make much sense to use ending balances for the other ratios, while using an average for inventory turnover. You need to use the ending balances to calculate turnover numbers in this problem. Its about consistency, in my mind anyhow.