Instructions

Supply Chain Management

Select a company of your choice, and calculate the most current days of working capital (DWC) that are available. Review page 656 in the textbook, and watch the short video segment “Working Capital,” which is one of the required unit resources in this unit. In addition to your calculations, include the information below in your essay.

• How does this company’s ratio compare to those of its competitors?
• Why is comparing this ratio to the industry average important?
• Explain how a well-managed supply chain can come into play here.

You may use the company’s webpage, or keep in mind that the CSU Online Library has several databases to choose from that are good starting points for your research:

• Mergent Online,
• Business Insights: Global,
• Business Source Ultimate, and
• ABI/INFORM Collection.

Your essay should be at least two pages in length. Use APA format to cite and reference all quoted and paraphrased material, including your textbook. Use a minimum of two sources, one of which may be the textbook. Include a title page, introduction, body, conclusion, and references page. An abstract is not required.

16-3 The Cash Conversion Cycle

All firms follow a “working capital cycle” in which they purchase or produce inventory, hold it for a time, and then sell it and receive cash. This process is known as the cash conversion cycle (CCC).

4The prime interest rate—the rate banks charge very good customers—hit 21% in the early 1980s. This produced

a level of business bankruptcies that was not seen again until 2009. The primary reason for the very high inter-est rate was that the inflation rate was up to 13%, and high inflation must be compensated by high interest rates. Also, the Federal Reserve was tightening credit in order to hold down inflation, and it was encouraging banks to restrict their lending.

16-3a Calculating the target CCC

Assume that Great Basin Medical Equipment (GBM) buys medical devices from manufac-turers in China and sells them in the United States, Canada, and Mexico. On average, it is 50 days from the time GBM purchases merchandise ($10 million a month) until the time GBM sells to its customers. GBM’s suppliers require payment within 40 days, but GBM gives its customers 60 days to pay for their purchases. GBM’s cash conversion cycle shows the net amount of time between GBM’s payments

to suppliers and GBM’s collections from customers. The cash conversion cycle has a big impact on GBM’s financing costs because GBM takes out bank loans to cover cash short-falls during this cycle. The following definitions are used in calculating the cycle length:

1. Inventory conversion period (ICP). This is the length of time between purchasing material or merchandise from suppliers and recording a sale to customers (which cre-ates an account receivable because GBM offers credit to its customers). GBM’s target is 50 days.5

2. Average collection period (ACP). This is the length of time customers are given to pay for goods following a sale. The ACP is also called the days sales outstanding (DSO). GBM’s business plan calls for an ACP of 60 days based on its 60-day credit terms. This is also called the receivables conversion period because it’s the number of days required to convert receivables into cash.

3. Payables deferral period (PDP). This is the length of time GBM takes to pay its sup-pliers. GBM’s suppliers allow it 40 days.6 On Day 1, GBM expects to buy merchandise, and it expects to sell the goods and thus

convert them to accounts receivable within 50 days. It should then take 60 days to collect the receivables, making a total of 110 days between receiving merchandise and collecting cash. However, GBM is able to defer its own payments for only 40 days. The net number of days in GBM’s target cash conversion cycle is shown in the following formula:

Cash

conversion cycle

5 Inventory

conversion period

5 50 5 70 days

1 Average

collection period

1 60 2

Payables deferral

period 2 40 Figure 16-2 diagrams the activities represented in Equation 16-1. Notice that GBM has

a 70-day cash shortfall that it must finance during the cycle. Although GBM is supposed to pay its suppliers $10 million by the 40th day after mak-ing the purchases, GBM does not expect to receive any cash until 110 days into the cycle: 50 1 60 5 110. Therefore, it will have to borrow the $10 million cost of merchandise from its bank on Day 40, and it does not expect to be able to repay the loan until it collects on Day 110. Thus, during its 70-day (110 2 40 5 70) target cash conversion cycle, it will owe the bank $10 million and accrue interest on this debt. All else equal, a shorter cash conver-sion cycle is preferable because a shorter CCC means lower interest charges.

5If GBM were a manufacturer, the inventory conversion period would be the time required to convert raw mate-rials into finished goods and then to sell those goods. 6

GBM’s payables deferral period corresponds to its suppliers’ average collection period. That is, if GBM takes 40 days to pay, then the supplier has to wait 40 days to collect its account receivable.

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