question archive Daphna Corporation has the following data, in thousands
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Daphna Corporation has the following data, in thousands. Assume a 365-day year.
Annual sales = €45,000
Annual cost of goods sold = €31,500
Average Inventory = €4,000
Average Accounts receivable = €2,000
Average Accounts payable = €2,400
Benchmark Cash Cycle (industry average) 52 days
Instructions:
1. Calculate the following:
a.Inventory period
b.Receivables period
c. Payables period
d.Operating cycle
e.Cash cycle
2. Answer the following:
a.How does the firm's cash cycle compare to its competitors? Is the firm performing better or worse than its competitors?
b.Explain some of the collection and disbursement techniques used by the companies to manage cash.
Answer 1 :
A. Inventory period : Average Inventory X 365 / Annual cost of goods sold
= 4000 X 365 / 31500 = 46.35 or 46 days.
B. Receivables period : Average accounts receivables X 365 / Annual sales
= 2,000 X 365 / 45,000 = 16.22 or 16 days.
C. Payables period : Average accounts payable X 365 / Annual cost of goods sold
= 2,400 X 365 / 31,500 = 27.81 or 28 days
D. Operating Cycle : Inventory period + Receivables period
= 46 + 16 = 62 days.
E. Cash cycle : Inventory period + Receivables Period - Payables period
= 46 + 16 - 28 = 34 days.
Answer 2a. Benchmark cash cycle is given in the question on the basis of industry average which is 52 days. While the firm's cash cycle is 34 days which is less the competitors. Rule of thumb says, lower the number of days, better it is for the firm. This shows that firm's performance is better as compare to the performance of its competitors. Generally cash cycle measures the liquidity risk of the company. It shows the time period by which company is deprived of cash. It measures the number of days by which Inventory is converted into sales then number of days which debtors take for making payment to the company or a firm and number of days which firm takes for making payment to its creditors. So in the basis of above calculations we can conclude that firm's performance is better than the competitors.
2b. Every company wants to maintain good level of liquidity. For maintaining effective level of liquidity, it is better for the company to reduce receivables payment period so that company can collect cash from its customers very frequently. On the other hand, its better for the company to increase the payables period so that it can pay cash to the suppliers after long time or less frequently and company can use the money of suppliers for the longer time period which is generally interest free.
cash collection techniques :
1. If company wants to collect cash from its customers within short span of time then it should offer cash discounts to the cutomers. It should tell the customers that if they make payment within 10 days then they will get extra discount say 5%.
2. As far as possible it should take advance from the customers.
3. Legal agreement or contract should be made that cutomer will make payment within set time limits.
4. Salesmen or collection owners must be appointed who are specialists in this work.
5. Regular call must be made or set reminders for the customers.
Cash disbursement techniques : Accounts payable department is responsible for this work. Head of the department should be careful while maintaining suppliers account. Vendor account reconciliation, cash management and payment authorization must be done carefully. Company should take care the suppliers seriously. It should try to reconcile the time between accounts receivables period and accounts payable period so that after receiving cash from the customers, payments can be made to the creditors.