Principles of Corporate Finance_ 12th Edition

766 Part Nine Financial Planning and Working Capital Management

bre44380_ch29_759-786.indd 766 10/06/15 09:53 AM

We can calculate the cash cycle for Dynamic Mattress. Suppose that it purchases materi-

als on day 0 but does not pay for them until day 24 (payable period = 24 days). By day 29

Dynamic has converted the raw materials into finished mattresses, which are then sold (inven-

tory period = 29). Twenty-one days later on day 50, Dynamic’s customers pay for their pur-

chases (receivables period = 21). Thus, cash went out of the door on day 24 and did not come

back in again until day 50. For Dynamic:

Cash cycle (days) = inventory period + accounts receivable period − accounts payable period

26 = 29 + 21 − 24

It is interesting to compare Dynamic’s cash cycle with that of other U.S. corporations.

Table 29.4 provides the information necessary to estimate the average cycle for manufactur-

ing firms:^8

Average inventory period = inventory at start of year/daily cost of goods sold

= 773/(6,181/365) = 45.6 days

Average receivables period = receivables at start of year/daily sales

= 718/(6,896/365) = 38.0 days

Average payment period = payables at start of year/daily cost of goods sold

= 557/(6,181/365) = 32.9 days

The cash cycle is therefore

Inventory period + receivables period − payables period

= 45.6 + 38.0 − 32.9 = 50.7 days

In other words, it is taking U.S. manufacturing companies an average of about six weeks from

the time they lay out money on inventories to collect payment from their customers. This

shows up in the working capital that companies need to maintain.

Of course, the cash cycle is much shorter in some businesses than in others. For example,

aerospace companies typically hold large inventories and offer long payment periods. Their

cash cycle is nearly six months, and they need to make a substantial investment in net work-

ing capital. By contrast, retail companies with their low investment in receivables have a cash

cycle that is similar to Dynamic’s. These companies often have negative working capital.

(^8) Because inventories are valued at cost, we divide inventory levels by cost of goods sold rather than sales revenue to obtain the inventory
period. This way, both numerator and denominator are measured by cost. The same reasoning applies to the accounts payable period.
On the other hand, because accounts receivable are valued at product price, we divide average receivables by daily sales revenue to
find the receivables period.
Income Statement
Sales $6,896
Cost of goods sold 6,181
Balance Sheet, Start of Year
Inventory $773
Accounts receivable 718
Accounts payable 557
❱ TABLE 29.4^ Data used to calculate the
cash cycle for U.S. manufacturing firms in
2014 (figures in billions).
Note: Cost of goods sold includes selling, general, and adminis-
trative expenses.
Source: U.S. Department of Commerce, Quarterly Financial Report
for Manufacturing, Mining, and Trade Corporations, December
2014, Tables 1.0 and 1.1.