Chapter 21, Problem 12P

Strickler Technology is considering changes in its working capital policies to improve its cash flow cycle. Strickler’s sales last year were $3,250,000 (all on credit), and its net profit margin was 7%. Its inventory turnover was 6.0 times during the year, and its DSO was 41 days. Its annual cost of goods sold was $1,800,000. The firm had fixed assets totaling $535,000. Strickler’s payables deferral period is 45 days.

1. a. Calculate Strickler’s cash conversion cycle.
2. b. Assuming Strickler holds negligible amounts of cash and marketable securities, calculate its total assets turnover and ROA.
3. c. Suppose Strickler’s managers believe the annual inventory turnover can be raised to 9 times without affecting sale or profit margins. What would Strickler’s cash conversion cycle, total assets turnover, and ROA have been if the inventory turnover had been 9 for the year?

Summary Introduction

To determine: Cash conversion cycle of Company S.

Explanation of Solution

Calculation of inventory and inventory conversion period:

$\begin{array}{c}\text{Inventory}=\frac{\text{COGS}}{\text{Inventory}\text{turnover}}\\ =\frac{\$1,800,000}{6}\\ =\$300,000\end{array}$

$\begin{array}{c}\text{Inventory conversion period}=\frac{\text{Inventory}}{\frac{\text{COGS}}{365}}\\ =\frac{\$300,000}{\left(\frac{\$1,800,000}{365}\right)}\\ =60.8\end{array}$

Therefore inventory is $300,000 and inventory conversion period is 60.8 days

Calculation of length of cash conversion cycle:

$\begin{array}{c}\text{Cash conversion cycle}=\text{Inventory}\text{conversion}\text{period}+\text{Average}\text{collection}\text{period}\\ -\text{Payables}\text{deferral}\text{period}\\ =60.8+41-4\text{5}\\ =56.8\text{days}\end{array}$

Hence, length of cash conversion cycle is 56.8 days.

Summary Introduction

To determine: Total assets turnover ratio and ROA.

Explanation of Solution

Calculation of total assets:

$\begin{array}{c}\text{DSO}=\frac{\text{Receivables}}{\text{Daily}\text{sales}}\\ \text{Receivables}=\text{DSO}\times \text{Daily sales}\\ =41\left(\frac{\$3,250,000}{365}\right)\\ =\$365,068.49\end{array}$

$\begin{array}{c}\text{Total}\text{assets}=\text{Inventory}+\text{receivables}+\text{fixed assets}\\ =\$300,000+\$365,068.49+\$535,000\\ =\$1,200,068.49\end{array}$

Hence, total assets of company are $1,200,068.49

Calculation of assets turnover ratio:

$\begin{array}{c}\text{Total}\text{assets}\text{turnover}=\frac{\text{Sales}}{\text{Total}\text{assets}}\\ =\frac{\$3,250,000}{\$1,200,068.49}\\ =2.7082\text{times}\end{array}$

Hence assets turnover is 2.7082 times

Calculation of ROA:

$\begin{array}{c}\text{ROA}=\text{Profit}\text{margin}\times \text{total}\text{assets}\text{turnover}\\ =0.07\times 2.7082\\ =18.96\%\end{array}$

Therefore, return on assets is 18.96%

Summary Introduction

To determine: Cash conversion cycle, total assets turnover and ROA if inventory turnover had been 9 for the current year.

Explanation of Solution

Calculation of inventory:

$\begin{array}{c}\text{Inventory }=\frac{\text{COGS}}{\text{Inventory turnover}}\\ =\frac{\$1,800,000}{9}\\ =\$20,000\end{array}$

Therefore, inventory is $20,000

Calculation of inventory conversion period:

$\begin{array}{c}\text{Inventory conversion period}=\frac{\text{Inventory}}{\frac{\text{COGS}}{\text{365}}}\\ =\frac{\text{\$200,000}}{\frac{\text{\$1,800,000}}{\text{365}}}\\ =40.6\text{days}\end{array}$

Therefore, the inventory conversion period is 40.6 days.

$\begin{array}{c}\text{Cash conversion cycle}=\text{Inventory}\text{conversion}\text{period}+\text{Average}\text{collection}\text{period}\\ -\text{Payables}\text{deferral}\text{period}\\ =40.6+41-4\text{5}\\ =36.6\text{days}\end{array}$

Cash conversion cycle is 36.6 days.

$\begin{array}{c}\text{Total}\text{assets}=\text{Inventory}+\text{receivables}+\text{fixed assets}\\ =\$200,000+\$365,068.49+\$535,000\\ =\$1,100,068.49\end{array}$

Hence, total assets of company are $1,100,068.49

Calculation of assets turnover ratio:

$\begin{array}{c}\text{Total}\text{assets}\text{turnover}=\frac{\text{Sales}}{\text{Total}\text{assets}}\\ =\frac{\$3,250,000}{\$1,100,068.49}\\ =2.9544\text{times}\end{array}$

Hence assets turnover is 2.9544 times

Calculation of ROA:

$\begin{array}{c}\text{ROA}=\text{Profit}\text{margin}\times \text{total}\text{assets}\text{turnover}\\ =0.07\times 2.9544\\ =20.68\%\end{array}$

Therefore, return on assets is 20.68%