Cash Conversion, Inventory, and Receivables Management Answers to Concept Review Questions

Chapter 19 Cash Conversion, Inventory, and Receivables Management

Answers to Concept Review Questions

1. What does the firm’s cash conversion cycle represent? What is the financial manager’s goal with regard to it? Why? The firm’s cash conversion cycle represents how quickly a firm turns its product, from paying for inventory to collecting cash from the customer in payment for finished goods. The financial manager’s goal is reduce the cash conversion cycle. The longer the cycle, the greater the need for interim financing to pay for the firm’s materials needs. The shorter the cycle, the sooner the firm receives cash that it can reinvest in the firm. A shorter cycle minimizes firm costs. 2. How should the firm manage its inventory, accounts receivable, and accounts payable in order to reduce the length of its cash conversion cycle? The firm should have the least amount of inventory possible (as long as there are no stockouts which result in lost sales), the least amount of accounts receivable (collect accounts receivable quickly) and the greatest amount of accounts payable (stretch payments as long as possible). 3. What are the general cost trade-offs that the financial manager must consider when managing the firm’s operating assets? How do these costs behave as a firm considers reducing its accounts receivable by offering more-restrictive credit terms? How can the optimum balance be determined? There are costs associated with holding too much and too little of each current asset and liability. For example, if a firm has a liberal credit policy, it will attract more customers, resulting in higher sales. However, it will have the cost of supporting the higher level of accounts receivable and possibly more bad debts. If the firm has more restrictive credit policies, it may lose sales to competitors with more liberal terms. The firm wants to find the amount of each asset that minimizes these competing costs. 4. What are the general cost trade-offs associated with the...