Assuming no change in days sales outstanding and days of inventory on hand, an issuer in need of cash flow that forgoes the discount offered by its vendor for payments within 10 days and chooses to pay on the due date in 30 days is:
A. shortening its cash conversion cycle.
B. lengthening its cash conversion cycle.
C. not affecting its cash conversion cycle.
In CFA website it says B is correct, why? I just don’t get it.
Not to me. I think A
CCC = DSO + DOI - DOP
If DOP increases
CCC reduces
I take it as how many sold inventory they can make in a year if they entirely use credit. So with longer payment time, they will be able to make less round inventory by credit → DOP decreases → CCC increases.
The other way to put it is the formula, which is 365 : COGS/ payable. Avg payable should increase since they dont get discount → DOP decreases → CCC increases.
Average payables = 100
COGS = 1000
DOP = (100 / 1000 ) x 365 = 36.5 days
They take longer to payables increase
Average payables = 200
COGS = 1000
DOP = (200 / 1000 ) x 365 = 73 days
If inventory would change then inventory of hand would change but it has not.
Yeah I used division and forgot payable was the denominator
Hi there,
I also encounter this same issue and I reached out to CFA support. It is true that this answer in CFA book is wrong. Should be A. Shortening
Replace:
B is correct. The issuer that uses the vendor financing by delaying
payments is increasing its days payable outstanding and thus
lengthening its cash conversion cycle. The issuer is reducing its
need for liquidity by taking advantage of the vendor financing at
the cost of the forgone discount.
With:
A is correct. The issuer that uses the vendor financing by delaying
payments is increasing its days payable outstanding and
thus shortening its cash conversion cycle. The issuer is reducing
its need for liquidity by taking advantage of the vendor financing
at the cost of the forgone discount.
A is correct
Hello
The correct answer is B, lengthening its cash conversion cycle.
By forgoing the discount and paying in 30 days instead of 10, the Days Payable Outstanding (DPO) increases. Since DPO is subtracted in the cash conversion cycle formula, increasing DPO lengthens the overall cycle.
Best regards,
nolanmaris
Hi nolanmaris, welcome to AnalystForum.
For this particular question, the answer in the study materials is wrong, and (as Liz points out 3 posts up) the correct answer is given in the Errata on the CFAI website