4. Cash conversion cycle

Cash management is a very important function of managers. Companies need to manage their operations in a way that they can sustain growth and yet not run out of cash.

Consider the case of the Red Hamster Manufacturing Inc.:

Red Hamster Manufacturing Inc. has forecasted sales of $27,000,000 for next year and expects its cost of goods sold (COGS) to remain at 60% of sales. Currently, the firm holds $3,100,000 in inventories, $1,800,000 in accounts receivable, and $2,800,000 in accounts payable.

Approximately how long does it take Red Hamster Manufacturing to convert its raw materials to its finished products and then to sell those goods? (Note: Use 365 days as the length of a year in all calculations, and round all values to two decimal places.)

76.83 days

62.86 days

69.85 days

48.90 days

On average, it takes from the time a sale is made until the time cash is collected from customers.

Red Hamster Manufacturing relies on customer credit when it buys raw materials from its suppliers. On average, it takes after the firm purchases materials before it sends cash to its suppliers. The length of Red Hamster Manufacturings cash conversion cycle (CCC) is . In general, firms prefer a CCC.

What is the length of Red Hamster Manufacturings cash conversion cycle (CCC)?

38.86 days

31.09 days

34.20 days

26.43 days

In general, firms prefer a CCC.

The management at Red Hamster Manufacturing wants to continue its internal discussions regarding its cash management. One of the finance team members presents the following case to her cohorts:

Case in Discussion

Lost Pigeon Aviations management plans to finance its operations with bank loans that will be repaid as soon as cash is available. The companys management expects that it will take 40 days to manufacture and sell its products and 35 days to receive payment from its customers. Lost Pigeon Aviations CFO has told the rest of the management team that they should expect the length of the bank loans to be approximately 75 days.

Which of the following responses to the CFOs statement is most accurate?

The CFOs approximation of the length of the bank loans should be accurate, because it will take 75 days for the company to manufacture, sell, and collect cash for its goods. All these things must occur for the company to be able to repay its loans from the bank.

The CFO is not taking into account the amount of time the company has to pay its suppliers. Generally, there is a certain length of time between the purchase of materials and labor and the payment of cash for them. The CFO can reduce the estimated length of the bank loan by this amount of time.

Is it possible for a firm to have a negative CCC?

No

Yes