5.) Managing Working Capital. A new computer system allows your firm to more accurately monitor inventory and anticipate future inventory shortfalls. As a result, the firm feels more able to pare down its inventory levels. What effect will the new system have on working capital and on the cash conversion cycle?
To determine the effect of the new computer system on working capital and the cash conversion cycle, we need to understand the relationship between inventory management and these financial metrics.
1. Working Capital: Working capital is the difference between a company's current assets (such as cash, inventory, and accounts receivable) and its current liabilities (such as accounts payable and short-term debt). It represents the funds available for day-to-day operations.
- Decreased Inventory Levels: The new computer system enables the firm to more accurately monitor inventory and anticipate future inventory shortfalls. This means the firm can reduce its inventory levels, resulting in lower inventory carrying costs. As a result, the firm's working capital will decrease.
2. Cash Conversion Cycle (CCC): CCC measures the length of time it takes for a company to convert its investments in inventory and other resources into cash inflows from sales. It includes three components: Days Inventory Outstanding (DIO), Days Sales Outstanding (DSO), and Days Payable Outstanding (DPO).
- Decreased Inventory Levels: By accurately monitoring inventory, the firm will be able to reduce its inventory levels. This will directly impact the DIO component of the CCC by reducing the number of days inventory is held before being sold. As a result, the CCC will decrease, indicating a more efficient conversion of inventory into cash.
Overall, the new computer system will have a positive impact on working capital and the cash conversion cycle by reducing inventory levels and improving efficiency in inventory management. It is important to note that the specific financial impact may vary depending on various other factors and the company's specific circumstances.