Supply Chains and Working Capital Management: Cash Conversion Cycle

All firms follow a "working capital cycle" in which they purchase or produce inventory, hold it for a time, and then sell it and receive cash. The -Select-operating cyclecash conversion cyclepayables deferral periodItem 1 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. The equation for this is as follows:

Cash conversion cycle = Inventory conversion period + Average collection period Payables deferral period

The -Select-inventory turnover ratioinventory conversion periodItem 2 is the average time required to convert raw materials into finished goods and then to sell them. It is calculated as follows:

Inventory conversion period (ICP) = Inventory/Cost of goods sold per day

The -Select-average collection periodreceivables turnover ratioaging scheduleItem 3 is also known as the days' sales outstanding. It is the average length of time required to convert the firm's receivables into cash, that is, to collect cash following a sale. It is calculated as follows:

Average collection period (ACP or DSO) = Receivables/(Sales/365)

The payables deferral period is the average length of time between the purchase of materials and labor and the payment of cash for them. It is calculated as follows:

Payables deferral period (PDP) = Payables/Daily purchases = Payables/(Cost of goods sold/365)

If a firm can sell goods faster, collect receivables faster, or defer its payable longer without hurting sales or increasing operating costs, its -Select-monthly cash budgetcash conversion cyclepayables deferral periodItem 4 would decline, its expected interest charges would be reduced, and its expected net income would be improved. This demonstrates that good working capital management is important to a firm's financial position and performance.

Quantitative Problem: Winston Inc. is trying to determine the effect of its inventory turnover ratio and days sales outstanding on its cash conversion cycle. Winston's 2017 sales (all on credit) were $174,000 and its cost of goods sold was 75% of sales. It turned over its inventory 8.82 times during the year. Its receivables balance at the end of the year was $13,102.52 and its payables balance at the end of the year was $7,392.06. Using this information calculate the firm's cash conversion cycle. Assume a 365-day year. Do not round intermediate calculations. Round your answer to one decimal place.

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