18: Cash Conversion, Inventory and Receivables Management18.3 Marginal profit from increased sales = λ Sales × CM
= λ Sales × (Price – VC)
18.4 (^) Averageinvestmentinaccountsreceivable(AIAR)=Totalvariablecostofannualsales
Turnoverofaccountsreceivable
18.5 Total variable cost of annual sales (TVC) = Annual unit sales × Variable cost/unit
18.6 (^) Turnoverofaccountsreceivable(TOAR)=^365
Averagecollectionperiod(ACP)
18.7 Cost of marginal investment in accounts receivable = Marginal investment × Required return
= (AIARproposed – AIARcurrent) × r
18.8 Bad debt expense (BDE) = Annual sales (Sales) × Bad debt expense rate (% BDE)
18.9 Cost of marginal bad debts = BDEproposed – BDEcurrent
18.10 Net profit for the credit decision = (Marginal profit from increased sales)
- (Cost of marginal investment in accounts receivable)
- (Cost of marginal bad debts)
18.11 (^) Averagecollectionperiod=Accountsreceivable
Averagesalesper day
KEY TERMS
ABC system, 637
ageing of accounts
receivable, 649
average collection period
(ACP), 640
average investment in accounts
receivable (AIAR), 645
carrying cost, 637
cash application, 651
cash conversion cycle (CCC), 629
cash discount, 646
collection policy, 648
contribution margin, 644
cost of the marginal investment
in accounts receivable, 645
credit monitoring, 648
credit scoring, 642
credit terms, 646
economic order quantity (EOQ)
model, 637
factoring, 641
five Cs of credit, 642
just-in-time (JIT) system, 639
manufacturing resource
planning II (MRPII), 639
material requirements planning
(MRP), 639
operating assets, 628
operating cycle (OC), 628
order cost, 637
payment pattern, 650
total cost, 637
total variable cost of annual
sales (TVC), 645
turnover of accounts receivable
(TOAR), 645
SELF-TEST PROBLEMS
Answers to Self-test problems and the Concept review questions throughout the chapter appear on
CourseMate with Smart Finance Tools at http://login.cengagebrain.com.
ST18-1 Aztec Products wishes to evaluate its cash conversion cycle (CCC). One of the company’s financial
analysts has discovered that, on average, the company holds items in inventory for 65 days, pays
its suppliers 35 days after purchase and collects its receivables after 55 days. The company’s
annual sales (all on credit) are about $2.1 billion, its cost of goods sold represent about 67% of
sales, and purchases represent about 40% of cost of goods sold. Assume a 365-day year.
a What is Aztec Products, operating cycle
(OC) and cash conversion cycle (CCC)?
b How many dollars of resources does
Aztec have invested in (1) inventory;
(2) accounts receivable; (3) accounts
payable; and (4) the total CCC?
c If Aztec could shorten its cash
conversion cycle by reducing its
inventory holding period by five days,
what effect would that have on its total
resource investment found in part (b)?