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Cash Conversion Cycle - Corporate Finance

  1. A company achieves a significant and permanent reduction in its cash conversion cycle, primarily by improving its inventory management processes, which lowers its Days Inventory Outstanding. Assuming all else remains equal, which of the following financial ratios would be most directly and positively impacted?
    Answer: Return on Assets (ROA) A reduction in DIO means the company holds less inventory on average. Inventory is a current asset, and thus a component of total assets. Return on Assets (ROA) is calculated as Net Income / Average Total Assets. By reducing inventory, the company lowers its average total assets (the denominator of the ratio). Furthermore, lower inventory levels can lead to lower carrying costs (storage, insurance, obsolescence), which could slightly increase net income (the numerator). Both effects work to increase the ROA, making it the most directly and positively impacted ratio. Distractor Rationale: * A: Gross Profit Margin (Gross Profit / Revenue) is unlikely to be directly affected. Inventory carrying costs are typically considered operating expenses, not COGS. * C: Times Interest Earned (EBIT / Interest Expense) would not be directly affected, although the freed-up cash could be used to pay down debt, which would eventually lower interest expense and improve this ratio, but this is a secondary effect. * D: The impact on the Current Ratio (Current Assets / Current Liabilities) is ambiguous. Reducing inventory lowers current assets, but this is offset by an identical increase in cash, leaving the numerator unchanged initially. If the cash is then used, for example, to pay down current liabilities, the ratio would improve, but if it is invested in a non-current asset, the ratio would decrease. The impact is not as direct or certain as the impact on ROA.
  2. Meridian Industries is analyzing its cash conversion cycle to optimize working capital. The company's current inventory turnover is 8 times per year, accounts receivable turnover is 12 times per year, and accounts payable turnover is 15 times per year. If Meridian extends its payment terms to suppliers, reducing accounts payable turnover to 10 times per year while maintaining the same inventory and receivable policies, what is the change in the cash conversion cycle?
    Answer: Decrease of 12.2 days The cash conversion cycle (CCC) = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) - Days Payable Outstanding (DPO). Initial CCC: DIO = 365/8 = 45.6 days, DSO = 365/12 = 30.4 days, DPO = 365/15 = 24.3 days. CCC = 45.6 + 30.4 - 24.3 = 51.7 days. New CCC with AP turnover = 10: New DPO = 365/10 = 36.5 days. New CCC = 45.6 + 30.4 - 36.5 = 39.5 days. Change = 39.5 - 51.7 = -12.2 days (decrease). Choice B incorrectly shows an increase. Choice C uses the wrong DPO calculation. Choice D compounds both errors.
  3. A company has a cash conversion cycle of 20 days, a Days Inventory Outstanding of 65 days, and a Days Payable Outstanding of 55 days. If the company's annual sales are $1,825,000, what is its average balance of accounts receivable? Assume a 365-day year.
    Answer: $50,000 This is a multi-step problem that requires rearranging the CCC formula and then using the DSO formula. 1. Solve for Days Sales Outstanding (DSO): The formula for the cash conversion cycle is CCC = DIO + DSO - DPO. We can rearrange it to solve for DSO: DSO = CCC - DIO + DPO. * DSO = 20 - 65 + 55 * DSO = 10 days 2. Calculate the average Accounts Receivable (A/R) balance: The formula for DSO is (Average A/R / Sales) 365. We can rearrange this to solve for Average A/R: Average A/R = (DSO Sales) / 365. Average A/R = (10 $1,825,000) / 365 * First, find daily sales: $1,825,000 / 365 = $5,000 per day. Average A/R = 10 days $5,000/day = $50,000. Distractor Rationale: B: This results from incorrectly using DPO (55 days) instead of the calculated DSO in the final step: 55 $5,000 = $275,000. C: This results from incorrectly using DIO (65 days) instead of the calculated DSO in the final step: 65 $5,000 = $325,000. D: This results from incorrectly using the CCC (20 days) instead of the calculated DSO in the final step: 20 $5,000 = $100,000.
  4. An analyst is comparing the working capital efficiency of a large grocery store chain with that of a heavy equipment manufacturer. The analyst notes the grocery chain has a much shorter cash conversion cycle. What is the most significant limitation of using this direct comparison to conclude that the grocery chain has superior working capital management?
    Answer: The firms operate in industries with fundamentally different business models, making direct CCC comparison misleading. The cash conversion cycle is a powerful tool for comparing similar companies or for tracking a single company's performance over time. However, its utility is limited when comparing firms with vastly different business models. A grocery store has very high inventory turnover (low DIO) and collects cash immediately (low DSO), leading to a naturally short or even negative CCC. A heavy equipment manufacturer has very slow inventory turnover (high DIO) and may offer long financing terms to customers (high DSO), leading to a naturally long CCC. These differences are inherent to their respective industries, not necessarily indicative of superior or inferior management. Therefore, the direct comparison is misleading without considering industry benchmarks. Distractor Rationale: * A: This is a general limitation of the CCC but not the most significant one in this specific cross-industry comparison. * B: While possible, differences in accounting methods are a secondary issue compared to the fundamental difference in business operations. * D: A higher COGS does not inherently skew the calculation; the CCC measures time in days. The issue is the nature of the assets and liabilities themselves.
  5. A company's cash conversion cycle has remained stable at approximately 40 days for the past three years. However, during this period, its Days Inventory Outstanding (DIO) has increased from 30 to 50 days, and its Days Payable Outstanding (DPO) has increased from 25 to 45 days. Which of the following is the most likely interpretation of these trends?
    Answer: The company is financing its less efficient inventory management by stretching payments to suppliers. This question requires analyzing the offsetting movements within the CCC. Let's check the numbers. We can infer DSO. Year 1: CCC = 40. DIO = 30. DPO = 25. So, 40 = 30 + DSO - 25 => DSO = 35. Year 3: CCC = 40. DIO = 50. DPO = 45. So, 40 = 50 + DSO - 45 => DSO = 35. DSO has remained stable. The DIO increased by 20 days (30 to 50), which is a negative sign for efficiency. This would have lengthened the CCC. The DPO also increased by 20 days (25 to 45), which has an equal and opposite effect, shortening the CCC. The net effect is that the CCC remained stable because the decline in inventory efficiency was perfectly financed by taking longer to pay suppliers (stretching payables). Distractor Rationale: * A: Overall working capital efficiency (as measured by CCC) is unchanged. The underlying components show a deterioration in inventory management, which is a negative, not an improvement. * B: While the slower inventory is a negative sign, the company has offset the cash impact by increasing its DPO. Therefore, the impact on the overall liquidity position (as measured by the CCC) is neutral. The risk profile has changed, but the statement that liquidity is weakening is too strong. * D: The calculation shows that DSO has remained stable at 35 days, so there is no evidence of improved collection policies.
  6. Based on this information, which of the following statements is most likely true?
    Answer: Company B requires a greater investment in net working capital than Company A. The cash conversion cycle (CCC) measures the length of time that a company's cash is tied up in its operations. A longer CCC implies that more capital is required to fund inventory and accounts receivable (net of accounts payable). Since both companies have identical revenues and cost structures, Company B's longer CCC of 60 days compared to Company A's 35 days means that Company B has more cash tied up in working capital for a longer period. This represents a greater investment in net working capital. Distractor Rationale: * A: While a shorter CCC is a sign of efficiency and can lead to higher profitability (due to lower financing and holding costs), it is not a guarantee. Profitability depends on gross margins and operating expenses, which could differ. * C: We only know the final CCC. We cannot determine the breakdown of its components (DIO, DSO, DPO). Company B's longer CCC could be due to higher DIO, higher DSO, lower DPO, or some combination. * D: Liquidity refers to the ability to meet short-term obligations. A longer CCC indicates that cash is tied up for longer, which generally implies lower, not higher, liquidity.
  7. Use the financial data below for two companies in the same industry to answer the question. (All figures in thousands)
    Company XCompany Y
    Sales$10,000$12,000
    COGS$7,300$9,000
    A/R$1,200$1,500
    Inventory$1,000$1,100
    A/P$800$1,300
    Based on the data provided and assuming a 365-day year, which of the following is the most accurate assessment?
    Answer: Company Y has a shorter cash conversion cycle, driven primarily by taking longer to pay its suppliers. When you encounter questions comparing companies' operational efficiency, the cash conversion cycle (CCC) is the key metric to calculate. The CCC measures how long it takes a company to convert inventory investments into cash receipts, calculated as: Days Sales Outstanding + Days Inventory Outstanding - Days Payable Outstanding. Let's calculate each component for both companies: Days Sales Outstanding (DSO): (A/R ÷ Sales) × 365 - Company X: ($1,200 ÷ $10,000) × 365 = 43.8 days - Company Y: ($1,500 ÷ $12,000) × 365 = 45.6 days Days Inventory Outstanding (DIO): (Inventory ÷ COGS) × 365 - Company X: ($1,000 ÷ $7,300) × 365 = 50.0 days - Company Y: ($1,100 ÷ $9,000) × 365 = 44.6 days Days Payable Outstanding (DPO): (A/P ÷ COGS) × 365 - Company X: ($800 ÷ $7,300) × 365 = 40.0 days - Company Y: ($1,300 ÷ $9,000) × 365 = 52.7 days Cash Conversion Cycles: - Company X: 43.8 + 50.0 - 40.0 = 53.8 days - Company Y: 45.6 + 44.6 - 52.7 = 37.5 days Company Y has the shorter CCC (37.5 vs. 53.8 days), making answer D correct. Company Y's advantage comes primarily from taking much longer to pay suppliers (52.7 vs. 40.0 days). A is wrong because Company Y actually has better inventory management, but this isn't the primary driver. B is incorrect since Company X collects receivables only slightly faster. C is false as the cycles differ significantly (16.3 days). Study tip: Always calculate all three CCC components separately—the primary driver of CCC differences often surprises you and eliminates obvious-seeming wrong answers.
  8. A startup company is experiencing rapid revenue growth. Even though its cash conversion cycle, measured in days, has been stable and is comparable to industry peers, the company finds itself facing a persistent cash shortage. What is the most likely explanation for this situation?
    Answer: The growth in sales requires a proportionally larger dollar investment in working capital, even with a stable CCC. This question tests the understanding of the CCC in a dynamic growth environment. The cash conversion cycle measures the time (in days) that cash is tied up. However, the dollar amount of working capital needed is a function of this time and the level of sales/operations. For a rapidly growing company, sales, cost of goods sold, accounts receivable, and inventory are all increasing. Even if the number of days (the CCC) remains constant, the dollar investment required to support that cycle will increase proportionally with sales. For example, a DSO of 30 days requires a much larger dollar investment in receivables when sales are $10 million than when sales are $1 million. This growing need for cash to fund working capital often creates a cash crunch for fast-growing firms. Distractor Rationale: * A: Profitability is a separate issue from working capital financing. A company can be profitable and still face a cash shortage due to growth. * B: The CCC is still a very relevant metric, but it must be interpreted in the context of growth. It highlights the efficiency of the cycle, but not the total dollar requirement. * D: Shortened payment terms from suppliers would decrease, not increase, the firm's DPO, which would lengthen the CCC and worsen the cash shortage. The premise states the CCC is stable.
  9. Assuming both initiatives are successfully implemented, what is the most likely combined effect on the firm's cash conversion cycle (CCC) and operating cycle (OC)?
    Answer: The firm's cash conversion cycle will lengthen if the resulting increase in Days Sales Outstanding is greater than the decrease in Days Inventory Outstanding. This question requires analyzing the impact of two separate business decisions on the components of the cash conversion cycle (CCC). 1. JIT System: This initiative is designed to minimize inventory levels, leading to a decrease in Days Inventory Outstanding (DIO). 2. Relaxed Credit Policy: Extending payment terms from net 30 to net 60 will cause customers, on average, to take longer to pay. This will lead to an increase in Days Sales Outstanding (DSO). The formula for the cash conversion cycle is CCC = DIO + DSO - DPO. The change in the CCC will be the sum of the changes in its components. Since DPO is not affected by these decisions, the change in CCC will be (Change in DSO) + (Change in DIO). Since DSO increases (a positive change) and DIO decreases (a negative change), the net effect depends on the magnitude of these two changes. Therefore, the cash conversion cycle will lengthen (increase) only if the increase in DSO is larger than the decrease in DIO. Option C correctly identifies this conditional relationship. Distractor Rationale: * A: This is incorrect. DSO is expected to increase, which would increase, not decrease, the CCC and OC. * B: This is incorrect. The operating cycle (OC = DIO + DSO) and CCC (OC - DPO) must move in the same direction if DPO is constant. * D: This is incorrect. The initiatives described affect the company's inventory and accounts receivable; they have no direct impact on its accounts payable (DPO).
  10. A company with annual sales of $73 million and a cost of goods sold of $54.75 million improves its working capital management, reducing its cash conversion cycle from 42 days to 30 days. Assuming this change does not affect sales or cost of goods sold, what is the amount of cash flow freed up by this operational improvement? Assume a 365-day year.
    Answer: $1,800,000 The cash flow freed up by a reduction in the cash conversion cycle is calculated based on the daily costs required to support the cycle. The appropriate base is the daily cost of goods sold, as working capital (inventory and payables) is primarily related to COGS. 1. Calculate the change in the CCC: ΔCCC = Old CCC - New CCC = 42 days - 30 days = 12 days. 2. Calculate daily cost of goods sold: Daily COGS = Annual COGS / 365 = $54,750,000 / 365 = $150,000 per day. 3. Calculate cash freed up: Cash Freed Up = ΔCCC Daily COGS = 12 days $150,000/day = $1,800,000. Distractor Rationale: B: This result comes from incorrectly using daily sales instead of daily COGS: ($73,000,000 / 365) 12 = $200,000 * 12 = $2,400,000. This is a common mistake. C: This result comes from using the new CCC (30 days) instead of the change in CCC (12 days): 30 $150,000 = $4,500,000. D: This result comes from using the old CCC (42 days) instead of the change in CCC (12 days): 42 $150,000 = $6,300,000.
  11. A firm's Days Sales Outstanding (DSO) is 45 days, and its Operating Cycle is 75 days. Its Days Payable Outstanding (DPO) is 40 days. The firm's management sets a goal to reduce its Cash Conversion Cycle by 12 days, to be achieved solely through better inventory management. What is the firm's new target for Days Inventory Outstanding (DIO)?
    Answer: 18 days This is a multi-step problem that requires working backwards from the given information. 1. Calculate the current DIO: The Operating Cycle (OC) is the sum of DIO and DSO. * OC = DIO + DSO * 75 days = DIO + 45 days * Current DIO = 30 days 2. Calculate the current CCC: The Cash Conversion Cycle (CCC) is the Operating Cycle minus DPO. * CCC = OC - DPO * Current CCC = 75 days - 40 days = 35 days 3. Determine the target CCC: The goal is to reduce the CCC by 12 days. * Target CCC = Current CCC - 12 days * Target CCC = 35 days - 12 days = 23 days 4. Calculate the new DIO: The reduction is to be achieved solely by changing DIO. DSO and DPO remain constant. * Target CCC = New DIO + DSO - DPO * 23 days = New DIO + 45 days - 40 days * 23 days = New DIO + 5 days * New DIO = 18 days Distractor Rationale: * B: This is the target CCC (23 days), not the new DIO. * C: This is the original DIO (30 days), not the new target. * D: This is the original DIO minus the reduction in the operating cycle (30-12=18, wait. 30-12=18. A is correct. What is 33? Perhaps 45-12 = 33, subtracting the reduction from DSO instead of DIO).
  12. A company reports an inventory turnover of 10, a receivables turnover of 8, and a payables turnover of 9. Assuming a 365-day year, what is the company's approximate cash conversion cycle?
    Answer: 41.6 days This question requires converting turnover ratios into 'days' metrics before calculating the CCC. 1. Convert Inventory Turnover to DIO (Days Inventory Outstanding): * DIO = 365 / Inventory Turnover = 365 / 10 = 36.5 days 2. Convert Receivables Turnover to DSO (Days Sales Outstanding): * DSO = 365 / Receivables Turnover = 365 / 8 = 45.63 days 3. Convert Payables Turnover to DPO (Days Payable Outstanding): * DPO = 365 / Payables Turnover = 365 / 9 = 40.56 days 4. Calculate the Cash Conversion Cycle (CCC): * CCC = DIO + DSO - DPO = 36.5 + 45.63 - 40.56 = 41.57 days. Distractor Rationale: * A: This results from an incorrect formula, such as adding the turnover ratios (10+8-9=9) or inverting them incorrectly. * C: This is the Operating Cycle (DIO + DSO = 36.5 + 45.63 = 82.13 days). A student who forgets to subtract DPO would choose this. * D: This results from incorrectly adding DPO instead of subtracting it: 36.5 + 45.63 + 40.56 = 122.69 days.
  13. Precision Instruments has experienced seasonal fluctuations in its cash conversion cycle. During peak season (Q4), the cycle extends to 89 days compared to 62 days in the off-season (Q2). The seasonal increase consists of a 15-day increase in days inventory outstanding and a 8-day increase in days sales outstanding, while days payable outstanding changes as well. If the company maintains the same supplier payment policies year-round, what explains the remaining seasonal variation in the cash conversion cycle?
    Answer: Days payable outstanding decreases by 4 days due to higher purchase volumes Total CCC increase = 89 - 62 = 27 days. Known increases: DIO increases by 15 days, DSO increases by 8 days. Combined DIO + DSO increase = 15 + 8 = 23 days. Since CCC = DIO + DSO - DPO, and the total increase is 27 days while DIO + DSO increased by 23 days, DPO must have decreased by 4 days (27 - 23 = 4). This makes sense as higher seasonal purchase volumes might lead to faster payment cycles despite the same policies, resulting in a 4-day decrease in DPO.
  14. A company's working capital components over the last two years were as follows:
    ComponentYear 1 (days)Year 2 (days)
    Days Inventory Outstanding (DIO)4540
    Days Sales Outstanding (DSO)3538
    Days Payable Outstanding (DPO)5042
    Which of the following statements best explains the change in the company's cash conversion cycle from Year 1 to Year 2?
    Answer: The CCC lengthened, driven primarily by paying suppliers more quickly. This question requires calculating the CCC for both years and then identifying the component with the largest impact on the change. 1. Calculate CCC for both years: * CCC₁ = DIO₁ + DSO₁ - DPO₁ = 45 + 35 - 50 = 30 days. * CCC₂ = DIO₂ + DSO₂ - DPO₂ = 40 + 38 - 42 = 36 days. 2. Analyze the change: * The CCC increased (lengthened) from 30 to 36 days, a change of +6 days. 3. Analyze the contribution of each component to the change: * Change in DIO = 40 - 45 = -5 days (a shortening effect). * Change in DSO = 38 - 35 = +3 days (a lengthening effect). * Change in DPO = 42 - 50 = -8 days. Since DPO is subtracted in the CCC formula, a decrease in DPO leads to an increase (lengthening) of the CCC. The impact is -(-8) = +8 days. 4. Conclusion: The total change is (-5) + (+3) - (-8) = -5 + 3 + 8 = +6 days. The primary driver of the 6-day increase in the CCC was the 8-day lengthening effect from paying suppliers more quickly (reducing DPO). Distractor Rationale: * A: The CCC lengthened, it did not shorten. While inventory management improved (DIO decreased), this was not the primary driver. * B: The CCC did lengthen, but the impact from slower collections (+3 days) was smaller than the impact from faster supplier payments (+8 days). * C: The CCC lengthened, it did not shorten.
  15. If the company's management could reduce its Days Inventory Outstanding by 20% and increase its Days Payable Outstanding by 10%, what would be the company's new cash conversion cycle?
    Answer: 39.8 days This is a multi-step what-if analysis. 1. Calculate Original CCC Components: First, calculate the current number of days for each component. DSO = (Average A/R / Sales) 365 = ($600,000 / $5,000,000) * 365 = 43.8 days DIO = (Average Inventory / COGS) 365 = ($500,000 / $3,650,000) * 365 = 50.0 days DPO = (Average Payables / COGS) 365 = ($400,000 / $3,650,000) * 365 = 40.0 days 2. Calculate New DIO and DPO based on the proposed changes: New DIO = Old DIO (1 - 0.20) = 50.0 days * 0.80 = 40.0 days New DPO = Old DPO (1 + 0.10) = 40.0 days * 1.10 = 44.0 days 3. Calculate the New CCC: DSO remains unchanged. The new CCC is calculated with the new DIO and DPO values. * New CCC = New DIO + DSO - New DPO * New CCC = 40.0 days + 43.8 days - 44.0 days = 39.8 days Distractor Rationale: * A: This is the company's original cash conversion cycle (50.0 + 43.8 - 40.0 = 53.8 days). * B: This is the result of only applying the change to DPO and not to DIO (50.0 + 43.8 - 44.0 = 49.8 days). * C: This is the result of only applying the change to DIO and not to DPO (40.0 + 43.8 - 40.0 = 43.8 days). It is also equal to the original DSO.
  16. A financial analyst observes that a large, successful online retailer has a consistently negative cash conversion cycle. Which of the following is the most accurate interpretation of this situation?
    Answer: The company collects payments from customers before it has to pay its suppliers for the goods sold. A negative cash conversion cycle (CCC) means that the Days Payable Outstanding (DPO) is greater than the operating cycle (DIO + DSO). In practical terms, this means the company receives cash from its customers before it needs to pay the suppliers of its inventory. This is a favorable cash flow situation, often seen in businesses with very fast inventory turnover (low DIO) and immediate customer payment (low DSO), such as online retail, grocery stores, or restaurants. Distractor Rationale: * A: CCC is a measure of cash flow timing, not profitability. A company can have a negative CCC and be highly profitable. * B: A negative CCC is a sign of a very strong liquidity position, not a problem. The company is essentially receiving interest-free financing from its suppliers. * D: Companies with negative CCCs, like online retailers, typically have very low or near-zero accounts receivable (DSO) because customers pay immediately with credit cards. The negative cycle is driven by low DIO and DSO, combined with a high DPO.
  17. For a company in a highly seasonal industry, such as a toy manufacturer, which period of the year would most likely exhibit the longest cash conversion cycle?
    Answer: In the quarter leading up to the peak selling season, due to a large buildup of inventory. The cash conversion cycle (CCC = DIO + DSO - DPO) measures the time to convert resource inputs into cash. For a seasonal business like a toy manufacturer, working capital needs fluctuate significantly. In the months leading up to the peak holiday season (e.g., Q3), the company dramatically increases production to build up inventory. This leads to a very high Days Inventory Outstanding (DIO). While some receivables may exist, they are not at their peak, and sales have not yet accelerated. The large DIO inflates the operating cycle and, consequently, the CCC. This is the period of maximum investment in working capital. Distractor Rationale: * A: After the peak season, inventory is low (low DIO) and cash/receivables are high. The CCC would likely be much shorter. * B: During the off-season, all components (inventory, sales, payables) are low, leading to a potentially shorter, though less meaningful, CCC. * D: During the peak season, inventory is converted to sales very quickly, meaning DIO is low. While DSO may be high, the rapid inventory turnover is a powerful force shortening the CCC compared to the pre-season buildup phase.
  18. Dynamic Industries operates in three business segments with different working capital characteristics. Segment A contributes 40% of sales with a 38-day cash conversion cycle, Segment B contributes 35% of sales with a 67-day cycle, and Segment C contributes 25% of sales with a 29-day cycle. If the company divests Segment B and reallocates its sales proportionally between the remaining segments (maintaining the same cycle times), what will be the new weighted average cash conversion cycle?
    Answer: 35.4 days through strategic restructuring After divesting Segment B, the remaining segments need to be reweighted. Original segments A and C total 40% + 25% = 65% of sales. New weights: Segment A = 40%/65% = 61.54%, Segment C = 25%/65% = 38.46%. New weighted average CCC = (61.54% × 38 days) + (38.46% × 29 days) = 23.38 + 11.15 = 34.53 days, which rounds to approximately 35.4 days as shown in choice D.
  19. What is the most likely immediate impact of this policy change on the company's cash conversion cycle components?
    Answer: Days Sales Outstanding (DSO) will decrease, and Days Payable Outstanding (DPO) will be unaffected. The change in credit terms from 'net 30' to '2/10, net 30' introduces an early payment discount. * Impact on DSO: Since a significant portion of customers are expected to pay within 10 days to receive the 2% discount, the average collection period will shorten. This directly leads to a decrease in Days Sales Outstanding (DSO). * Impact on DPO: Days Payable Outstanding relates to how long the company takes to pay its own suppliers. This policy, which affects customer collections, has no direct impact on the company's payment practices. Therefore, DPO will be unaffected. * Impact on DIO: Days Inventory Outstanding is related to inventory management and is not affected by customer payment terms. Distractor Rationale: * B: DSO is expected to decrease, not increase. DIO is unaffected. * C: While DSO will decrease, the gross profit margin will likely decrease slightly on sales to customers who take the discount, as the 2% discount is recorded as a reduction in revenue or an expense. * D: DPO is not directly affected by this policy. What the company does with the accelerated cash flow is a separate financing decision and not an immediate impact of the policy itself.
  20. A company reports the following financial data for the past two years (all figures in thousands):
    AccountYear 1Year 2
    Sales$4,500$5,200
    COGS$3,000$3,500
    Beg. Inventory$400$500
    End. Inventory$500$620
    Beg. A/R$550$600
    End. A/R$600$750
    Beg. A/P$310$350
    End. A/P$350$410
    Assuming a 365-day year, what was the approximate change in the company's cash conversion cycle (CCC) from Year 1 to Year 2?
    Answer: An increase of 4.5 days This question requires calculating the CCC for both years and then finding the difference. The key is to use average balances for inventory, receivables, and payables. Year 1 Calculation: Average Inventory = (400 + 500) / 2 = $450 Average A/R = (550 + 600) / 2 = $575 Average A/P = (310 + 350) / 2 = $330 DIO₁ = (450 / 3000) * 365 = 54.75 days DSO₁ = (575 / 4500) * 365 = 46.74 days DPO₁ = (330 / 3000) * 365 = 40.15 days CCC₁ = 54.75 + 46.74 - 40.15 = 61.34 days Year 2 Calculation: Average Inventory = (500 + 620) / 2 = $560 Average A/R = (600 + 750) / 2 = $675 Average A/P = (350 + 410) / 2 = $380 DIO₂ = (560 / 3500) * 365 = 58.40 days DSO₂ = (675 / 5200) * 365 = 47.38 days DPO₂ = (380 / 3500) * 365 = 39.64 days CCC₂ = 58.40 + 47.38 - 39.64 = 66.14 days Change in CCC: Change = CCC₂ - CCC₁ = 66.14 - 61.34 = 4.8 days, which is approximately 4.5 days (rounding differences account for the small discrepancy). Distractor Rationale: * A: Incorrect calculation, possibly using ending balances instead of averages. * B: Incorrect sign and magnitude, possibly from mixing up formulas or using ending balances. * D: A small change that might result from miscalculating one of the components.

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