Receivables Investment McDowell Industries Sells On
Sheet1166 Receivables Investmentmcdowell Industries Sells On Terms Of
Analyze McDowell Industries' receivables management by calculating the days sales outstanding, average receivables, and assessing potential impacts on receivables if collection policies change. Additionally, evaluate the effective cost of trade credit for Masson Corporation, determine the cash conversion cycle for Zocco Corporation, and analyze Christie Corporation's cash flow cycle, total assets turnover, and return on assets under varying inventory turnover scenarios.
Paper For Above instruction
Effective management of accounts receivable, credit terms, and working capital is critical for maintaining liquidity and profitability in manufacturing and retail firms. This paper systematically analyzes key financial metrics related to receivables, trade credit, and cash conversion cycle parameters for McDowell Industries, Masson Corporation, Zocco Corporation, and Christie Corporation, highlighting how strategic adjustments can influence their financial health.
Receivables Management at McDowell Industries
McDowell Industries sells on credit terms of 3/10, net 30. This means that customers can avail a 3% discount if paid within 10 days, otherwise, the full amount is due in 30 days. The company reports total annual sales of $912,500, with 40% of customers paying on the 10th day (taking advantage of discounts), and the remaining 60% paying on average after 40 days from the date of sale.
A. Days Sales Outstanding (DSO):
The DSO can be computed as a weighted average based on customer payment behavior:
- Payments within 10 days (discount customers): 40% of sales
- Payments after 40 days (non-discount customers): 60% of sales
Thus, the DSO is:
DSO = (Percentage paying early Days to payment) + (Percentage paying late Days to payment)
DSO = (0.40 10 days) + (0.60 40 days) = 4 + 24 = 28 days
This indicates that, on average, receivables are outstanding for approximately 28 days.
B. Average Accounts Receivable:
The average accounts receivable (A/R) can be computed by:
A/R = (DSO / 365) * Total annual sales
A/R = (28 / 365) $912,500 ≈ 0.0767 $912,500 ≈ $70,094
Therefore, McDowell Industries’ average receivables balance is approximately $70,094.
C. Impact of a Tighter Collection Policy:
If McDowell mandates that all non-discount customers pay on the 30th day instead of 40 days, the average collection period would increase, affecting receivables. To assess this, we consider the new average DSO:
- Discount customers continue paying early at 10 days.
- Non-discount customers now pay on day 30.
New DSO = (0.40 10) + (0.60 30) = 4 + 18 = 22 days
However, since the average payment days would decrease under this stricter policy (from 28 to 22 days), the average receivables would decline accordingly:
A/R new = (22 / 365) $912,500 ≈ 0.0603 $912,500 ≈ $55,066
Hence, tightening collection policies can reduce receivables by approximately $15,000, freeing up working capital but potentially impacting customer relationships.
Cost of Trade Credit for Masson Corporation
Masson Corporation requires $500,000 for one year and currently benefits from trade credit terms of 3/10, net 90, paying early on the 10th day to obtain discounts. Alternatively, it could forgo discounts, pay on the 90th day, and effectively finance its working capital through trade credit.
The implied interest rate of this deferred payment can be computed as the cost of forgoing the discount, annualized:
- Discount rate: 3% (on payment within 10 days)
- Period of the discount: 10 days
- Payment postponement: from day 10 to day 90 (80 days)
The interest rate for the 80-day period is:
Interest = Discount amount / (1 - Discount rate) = 0.03 / (1 - 0.03) ≈ 0.03093
Annualized effective interest rate (EAR) is calculated as:
EAR = [(1 + interest per period)^(number of periods in a year)] - 1
Number of such periods in a year = 365 / 80 ≈ 4.56
EAR = (1 + 0.03093)^4.56 - 1 ≈ 1.147 - 1 = 0.147 or 14.7%
This signifies that by preserving the payment delay from day 10 to day 90 instead of paying early to get the discount, Masson effectively incurs an annual interest cost of approximately 14.7%.
Zocco Corporation’s Cash Conversion Cycle
Zocco Corporation's operating metrics include an inventory conversion period of 60 days, an accounts receivable collection period of 38 days, and a payables deferral period of 30 days. Cost of goods sold (COGS) is 75% of sales, providing a basis for understanding inventory turnover and working capital needs.
A. Length of the Cash Conversion Cycle (CCC):
The CCC is a key metric representing the time interval between outlays of cash for inventory and cash inflows from receivables, less the period deferring payments to suppliers:
CCC = Inventory Conversion Period + Receivables Collection Period - Payables Deferral Period
CCC = 60 + 38 - 30 = 68 days
B. Investment in Accounts Receivable:
Given annual sales of $3,421,875 and an average collection period of 38 days, the average accounts receivable (A/R) is:
A/R = (Collection period / 365) * Total sales
A/R = (38 / 365) $3,421,875 ≈ 0.1041 $3,421,875 ≈ $356,543
C. Inventory Turnover Rate:
Inventory turnover is calculated as COGS divided by average inventory. First, determine COGS:
COGS = 75% of sales = 0.75 * $3,421,875 ≈ $2,566,406
Inventory turnover rate = COGS / Average inventory
Average inventory is derived from the inventory conversion period:
Inventory Conversion Period = 60 days, so:
Average Inventory = (Inventory Conversion Period / 365) COGS = (60/365)$2,566,406 ≈ $421,445
Inventory Turnover = $2,566,406 / $421,445 ≈ 6.09 times per year
Christie Corporation’s Cash Flow and Asset Efficiency
Christie Corporation's sales last year totaled $150,000 with a net profit of 6%, indicating profitability and efficient management. Its operating metrics include inventory turnover of 7.5 times and a DSO of 36.5 days. Payables deferral period is 40 days, and fixed assets total $35,000. The goal is to understand how changes in inventory turnover influence cash flow cycle, total asset utilization, and profitability metrics.
A. Cash Conversion Cycle (CCC):
CCC = Inventory Conversion Period + DSO - Payables Deferral Period
Inventory Conversion Period = 365 / Inventory turnover = 365 / 7.5 ≈ 48.67 days
CCC = 48.67 + 36.5 - 40 = 45.17 days
B. Total Assets Turnover and Return on Assets (ROA):
Total assets turnover is computed as sales divided by total assets:
Total Assets Turnover = $150,000 / $35,000 ≈ 4.29 times
ROA = Net Profit / Total Assets = $9,000 / $35,000 ≈ 25.7%
C. Predicted impact of Higher Inventory Turnover (to 9 times):
If inventory turnover increases to 9:
New inventory conversion period = 365 / 9 ≈ 40.56 days
Revised CCC = 40.56 + 36.5 - 40 ≈ 36.06 days
New total assets turnover = $150,000 / $35,000 ≈ 4.29 (unchanged directly by inventory turnover, but higher turnover typically indicates higher efficiency)
ROA remains similar unless net profit margins are affected; however, operational efficiency improves, leading eventually to potential ROA enhancement.
Conclusion
Effective receivables management and working capital policies are essential for optimizing a company's cash flow and profitability. McDowell Industries can reduce receivables by tightening collection policies, potentially freeing working capital. Masson’s calculation of trade credit cost highlights the importance of understanding implicit financing costs inherent in supplier credit terms. Zocco Corporation’s cash cycle elucidates how inventory management, receivables, and payables interact to influence liquidity needs. Lastly, Christie Corporation demonstrates how operational efficiencies, such as improved inventory turnover, enhance asset utilization and profitability. Strategic adjustments in these areas can significantly impact financial performance and stability.
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