[Carleather55]

What effect will the following hgave on a cash conversion cycle:
a) Higher financing rates induce the firm to reduce its level of inventory
b) the firm obtains a new line of crdit that enables it to avoid stretching payables to its suppliers
c. the firm factors its accounts receivables
d. a recession occurs, and the firm';s customers increasingly sgtretch their payables

[morgaine300]

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[Carleather55]

I am just not sure how to answer this without more details but I came up with the following:
a. Lengthen not sure why I think it lengthens the cash conversion cycle
b. Shorten - although receivables nay not have been collected - company has funds to eliminate payables.
c. Shorten - factoring allows for instant cash thus allowing conpany to pay its vendors
d. lengthen- the longer it takes for a customer to pay,m means the company cannot pay their bills

[ArcSine]

You're correct on (c) and (d), although your "follow-throughs" have the effect of unwinding your original correct answer.

Factoring the receivables would indeed compress the cash conversion cycle, all other factors (no pun intended) held constant. But if the firm uses the accelerated cash collections to pay its AP sooner (as your follow-up suggests), that will have the effect of lengthening the CCC.

Ditto for (d)... the direct effect of customers paying later is a stretching of the CCC... but if the company starts stretching out its own vendors in response, this effect is at least partially reversed.

So I think the question just wants you to give the direct effect on the CCC (which you've done correctly for (c) and (d)), but without following up with a possible secondary effect on CCC, as a result of what the company might do in response.

You'll want to re-think (a). If the company reduces its inventory levels, it means that on average, an item of inventory is "in-house" for a shorter period, from acquisition to sale. For example, if the company has average daily sales of $10 (in terms of cost), and they routinely carry $80 of inventory, then on average an inventory item is in the warehouse for 8 days, before going out the door under a customer's arm. Reduce the inventory stock to $50, then there's only an average of 5 days from acquisition to sale.

If customers consistently pay, say, 20 days after the sale, then the average length of time from the day the company acquires an item of inventory, to the day they collect from the customer, drops from 28 days to 25. Assuming the company's pay-cycle with its vendor doesn't change, then the CCC drops by the same amount.

(b) is a bit trickier, but let's stick with direct effects only. If the company begins paying its vendors sooner as a result of the credit line, that serves to increase the gap between payments to vendors, and collections from customers.

I'll agree that if the company begins financing its vendor payments with the credit line, then the true 'pay date' for the inventory (in cash flow terms) is not when the vendors get paid, but rather when the credit line is paid. But I'd be surprised if your book or background material wants you to take this into account.

Good luck,