Cash Management Efficiency
Lisa Pinto, vice president of finance at Roche Publishing Company, a rapidly growing
publisher of college texts, is concerned about the firmâ€™s high level of short-term
resource investment. She believes that the firm can improve the management of its
cash and, as a result, reduce this investment. In this regard, she charged Arlene
Bessenoff, the treasurer, with assessing the firmâ€™s cash management efficiency. Arlene
decided to begin her investigation by studying the firmâ€™s operating and cash conversion
Arlene found that Rocheâ€™s average payment period was 25 days. She consulted
industry data, which showed that the average payment period for the industry was 40
days. Investigation of three similar publishing companies revealed that their average
payment period was also 40 days. She estimated the annual cost of achieving a 40-day
payment period to be $53,000.
Next, Arlene studied the production cycle and inventory policies. The average
age of inventory was 120 days. She determined that the industry standard as reported
in a survey done by Publishing World, the trade association journal, was 85 days. She
estimated the annual cost of achieving an 85-day average age of inventory to be
Further analysis showed Arlene that the firmâ€™s average collection period was 60
days. The industry average, derived from the trade association data and information
on three similar publishing companies, was found to be 42 daysâ€”30% lower than
Rocheâ€™s. Arlene estimated that if Roche initiated a 2% cash discount for payment
within 10 days of the beginning of the credit period, the firmâ€™s average collection
period would drop from 60 days to the 42-day industry average. She also expected
the following to occur as a result of the discount: Annual sales would increase from
$13,750,000 to $15,000,000; bad debts would remain unchanged; and the 2% cash
discount would be applied to 75% of the firmâ€™s sales. The firmâ€™s variable costs equal
80% of sales.
Roche Publishing Company is currently spending $12,000,000 per year on its
operating-cycle investment, but it expects that initiating a cash discount will increase
its operating-cycle investment to $13,100,000 per year. (Note: The operating-cycle
investment per dollar of inventory, receivables, and payables is assumed to be the
same.) Arleneâ€™s concern was whether the firmâ€™s cash management was as efficient as it
could be. Arlene knew that the company paid 12% annual interest for its resource
investment and therefore viewed this value as the firmâ€™s required return. For this
reason, she was concerned about the resource investment cost resulting from any inefficiencies
in the management of Rocheâ€™s cash conversion cycle. (Note: Assume a 365-
a. Assuming a constant rate for purchases, production, and sales throughout the
year, what are Rocheâ€™s existing operating cycle (OC), cash conversion cycle
(CCC), and resource investment need?
b. If Roche can optimize operations according to industry standards, what would
its operating cycle (OC), cash conversion cycle (CCC), and resource investment
need be under these more efficient conditions?
c. In terms of resource investment requirements, what is the annual cost of Rocheâ€™s
d. Evaluate whether Rocheâ€™s strategy for speeding its collection of accounts receivable
would be acceptable. What annual net profit or loss would result from
implementation of the cash discount?
e. Use your finding in part d, along with the payables and inventory costs given,
to determine the total annual cost the firm would incur to achieve the industry
level of operational efficiency.
f. Judging on the basis of your findings in parts c and e, should the firm incur the
annual cost to achieve the industry level of operational efficiency? Explain why
or why not.