Fundamentals of Financial Management (Concise 6th Edition)

480 Part 6 Working Capital Management, Forecasting, and Multinational Financial Management

decline, its interest charges would be reduced, and its pro! ts and stock price would

be improved.

15-4b Calculating the CCC from Financial Statements

The preceding section illustrates the CCC in theory; but in practice, we would cal-

culate the CCC based on the! rm’s! nancial statements. Moreover, the actual CCC

would almost certainly differ from the theoretically forecasted value because of

real-world complexities such as shipping delays, sales slowdowns, and customer

delays in making payments. Moreover, a! rm such as GFI would start a new cycle

before the earlier one ended, and this too would muddy the waters.

To see how the CCC is calculated in practice, assume that GFI has been in busi-

ness for several years and is now in a stable position—placing orders, making

sales, obtaining collections, and making payments on a recurring basis. The fol-

lowing data were taken from its latest! nancial statements:

Annual sales $1,216,666

Cost of goods sold 1,013,889

Inventory 250,000

Accounts receivable 300,000

Accounts payable 150,000

We begin with the inventory conversion period:

15-2 Inventory conversion period!

Inventory

Cost _______________________of goods^ sold^ per day^

! ______________$250,000

$1,013,889/365

! 90 days

Thus, it takes GFI an average of 90 days to sell its merchandise, not the 60 days

called for in the business plan. Note also that inventory is carried at cost; so the

denominator of the equation should be the cost of goods sold, not sales.

The average collection period (or days sales outstanding) is calculated next:

15-3 Average collection period! Receivables___________

Sales/365

! ______________$300,000

$1,216,666/365

! 90 days

So it takes GFI 90 days after a sale to receive cash, not the 60 days called for in the

business plan. Because receivables are recorded at the sales price, we use sales

rather than cost of goods sold in the denominator.

The Cash Conversion Cycle

F I G U R E 1 5! 3

Finish Goods

and Sell Them

Receive

Materials

Pay Cash for

Purchased

Materials

Collect Cash

for Accounts

Receivable

Days

Inventory

Conversion

Period (60 Days)

Average

Collection

Period (60 Days)

Payables

Deferral

Period (40 Days)

Cash

Conversion

Period (80 days)