GF583 Unit 2 Distributor Cash Cycle Exercise Example

45.1 Days on Averages, 40.9 at Year End: A Unit 2 Cash Conversion Cycle Exercise for a Distributor

[Student Name]

Purdue University Global

GF583: Treasury Management I

Unit 2 Cash Conversion Cycle Exercise

[Instructor Name]

[Date]

The distributor, its supplier program and every figure are composite and illustrative, in millions of dollars; the articles and textbook cited are real.

The Supplied Figures

Annual sales: 2,380.0. Cost of goods sold: 1,999.2. Average of the four quarter-end balances: inventory 318.6, receivables 231.4, payables 266.2. Year-end balances: inventory 300.0, receivables 220.0, payables 261.0. All amounts are in millions of dollars, and day counts use a 365-day year.

Part 1: The Cycle on Average Balances

Days inventory outstanding. Inventory over annual cost of goods sold, scaled to a 365-day year: 318.6 divided by 1,999.2, times 365, about 58.2 days.

Days sales outstanding. Receivables divided by sales, times 365: 231.4 divided by 2,380.0, times 365, about 35.5 days.

Days payables outstanding. Payables over the same cost base, scaled the same way: 266.2 divided by 1,999.2, times 365, about 48.6 days.

Cash conversion cycle. 58.2 plus 35.5 less 48.6, about 45.1 days.

Meaning. From the day the company pays a supplier to the day a clinic pays the company, about 45 days pass on average. Every one of those days must be financed with cash or borrowing.

Part 2: Why Year-End Balances Give a Shorter Cycle

On year-end balances, inventory days are about 54.8, receivable days about 33.7 and payable days about 47.7, for a cycle of about 40.9 days.

The difference, more than four days, comes from seasonality. The distributor's year ends in December, after the fall vaccine season has been sold and collected, when inventory and receivables are at their lowest. The average of four quarter-ends includes the spring build, when inventory swells ahead of the vaccination season. A cycle computed on year-end balances describes the company at its leanest moment, not its typical one (Richards & Laughlin, 1980).

Part 3: What One Day Is Worth

With cost of goods sold of 1,999.2, one day of payables is worth about 5.5. With sales of 2,380.0, one day of receivables is worth about 6.5. Shortening receivable days by one would release about $6.5 million; at the company's 5.30 percent borrowing rate, that saves about $345,000 a year in interest. Pricing each day this way turns the cycle from a ratio into a budget item the treasurer can weigh against the cost of changing terms (Kallberg & Parkinson, 1993).

Part 4: The Supplier Program Behind the Payables

The payables figure looks healthy, but much of it depends on one arrangement. The company's largest vaccine manufacturer offers 120-day terms on pre-season orders placed before February, against its normal 45 days. About 37.2 of average payables come from those extended orders. Without the program, payables would fall by about 37.2 and payable days by about 6.8, lengthening the cycle to about 51.9 days.

The 45.1-day cycle looks like efficient working capital management, but nearly seven days of it are a gift from one manufacturer's marketing program, which could be changed or withdrawn at the manufacturer's choice.

Part 5: How the Distributor Compares

A study of Belgian firms found that companies with shorter receivable and inventory periods tended to earn more, which suggests the cycle is a lever on profit and not only on liquidity (Deloof, 2003). Industry data for pharmaceutical and medical distributors show cycles ranging widely, because large national distributors negotiate long supplier terms that smaller regional firms cannot. A regional distributor with a 45-day cycle is doing reasonably well, but its advantage depends on one supplier's terms in a way a larger firm's does not.

Part 6: What the Treasurer Should Watch

Three measures deserve monthly tracking. Receivable days, because the largest clinic groups have begun asking for longer terms. Inventory days during the spring build, when a late vaccine season can leave stock on hand for weeks. And the share of payables under the manufacturer's extended program, because a change in that program would hit cash by more than $37 million within a quarter.

What Would Shorten the Cycle

Three levers are available, each with a cost. Inventory days could fall by about five if the company ordered vaccines in two tranches rather than one pre-season order, but the manufacturer's extended terms apply only to orders placed before February, so splitting orders would also shorten payable days. Receivable days could fall by two or three if the largest clinic groups paid electronically on the due date, as a later unit proposes. Payable days are already long and should not be stretched further without the suppliers' agreement. The net realistic gain is about three days, worth roughly $19 million of cash at the current scale.

A Note on Reporting

The cycle reported to the board should use average balances, with the year-end figure shown beside it and a sentence explaining the difference, so directors do not mistake the company's leanest month for its normal position.

Checks

Each component was recomputed on a 360-day year as a check: the cycle becomes about 44.4 days, close enough that no conclusion moves. Average-balance figures were also compared with the monthly balances available for the second half of the year, which give a cycle within half a day of the quarterly average.

References

Deloof, M. (2003). Does working capital management affect profitability of Belgian firms? Journal of Business Finance & Accounting, 30(3-4), 573-588. https://doi.org/10.1111/1468-5957.00008

Kallberg, J. G., & Parkinson, K. L. (1993). Corporate liquidity: Management and measurement. Irwin.

Richards, V. D., & Laughlin, E. J. (1980). A cash conversion cycle approach to liquidity analysis. Financial Management, 9(1), 32-38. https://doi.org/10.2307/3665310