Calder Supply's Cash Conversion Problem
Calder Supply distributes restaurant equipment. Sales last year were $7.3 million, all on credit, and net income was $310,000. The balance sheet shows accounts receivable of $1.24 million, inventory of $1.05 million, and accounts payable of $560,000; cost of goods sold was $5.1 million. Calder has a $750,000 revolving line of credit at 9.5 percent and had to draw $400,000 of it in the fourth quarter just to make payroll. A major supplier offers 2/10, net 45 on $1.8 million of annual purchases; Calder currently pays on day 45. The controller proposes taking the discount on every invoice, which would require about $173,000 of additional borrowing on average. Separately, the sales manager suggests offering customers 1/10, net 30 to speed up collections; the average collection period is 62 days, and about 20 percent of sales would qualify for the discount.
1. Calculate Calder's cash conversion cycle and explain what it tells management about the business.
Read the worked answer
Days sales outstanding = $1.24M ÷ $7.3M × 365 = 62.0 days. Days inventory outstanding = $1.05M ÷ $5.1M × 365 = 75.1 days. Days payable outstanding = $560K ÷ $5.1M × 365 = 40.1 days. Cash conversion cycle = 62.0 + 75.1 − 40.1 = 97.0 days.
Interpretation. Calder waits 62 days for customers and holds stock 75 days, while paying suppliers in 40 - so roughly 97 days of operating cash is financed by the company, not by its trading partners. Every additional $1,000 of sales requires about 97 days of working capital before it returns as cash, which is why a $310,000 profit year ended with a $400,000 line draw. Profit and cash are diverging: growth is consuming the cash the income statement says was earned.
Where the leverage is. Inventory is the largest single block at 75 days. For a distributor of equipment with many SKUs, that usually signals slow-moving items rather than a need for more stock. Payables at 40 days sit below the 45-day terms offered, suggesting bills are being paid slightly early or on a scattered schedule - free financing left on the table. Collecting even five days faster would free about $100,000; cutting inventory by 15 days would free roughly $210,000, more than enough to retire the line draw.
2. Should Calder take the supplier's 2/10, net 45 discount? Show the comparison and note any constraint that could override the arithmetic.
Read the worked answer
Cost of forgoing the discount. Paying on day 45 instead of day 10 buys 35 extra days of credit at a price of 2 percent of the invoice: (2 ÷ 98) × (365 ÷ 35) = 2.04% × 10.43 = 21.3% annualized. That is far above Calder's 9.5 percent line rate, so the discount is cheap money. Take it.
Dollar check. Discount captured = 2% × $1.8M = $36,000 a year. Extra borrowing = $1.8M × 35 ÷ 365 ≈ $172,600 on average, costing $172,600 × 9.5% = $16,400. Net benefit ≈ $19,600 a year, before any improvement in supplier relationship or pricing.
The constraint that could override this. Calder's line is $750,000 with $400,000 already drawn, leaving about $350,000 of headroom. The $172,600 need fits, but only barely, and it competes with the cash already consumed by inventory and receivables. If inventory and receivables are not addressed, adding discount-driven borrowing could exhaust the line and leave the company unable to meet a payroll week.
Recommended sequencing: first negotiate a temporary increase in the revolver or ask the supplier for extended dating (for example, 2/10, net 60), then take the discount selectively on the largest invoices, and renegotiate terms annually. Take the discount, but not before the liquidity headroom is confirmed in writing.
3. Evaluate the proposed 1/10, net 30 customer discount and recommend an alternative if you reject it.
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Cost. One percent on the 20 percent of sales that would take it = 1% × 20% × $7.3M = $14,600 a year, before considering that many of those customers already pay on time.
Benefit. If participating customers cut their payment time sharply, overall DSO might fall by roughly four days. Four days of sales = 4 ÷ 365 × $7.3M ≈ $80,000 of receivables released, worth $80,000 × 9.5% ≈ $7,600 a year in interest. On those assumptions the program is net negative by about $7,000, and it hands a discount to reliable payers who need no incentive.
Why the average misleads. A single average collection period hides the distribution. If 62 days is the average, some accounts are probably at 90+ days and pulling the mean upward. Discounting everyone to fix a minority of slow payers is expensive.
Better alternatives:
- Segment the receivables aging and offer terms only to accounts above 60 days, where the marginal collection benefit is real.
- Tighten credit approval and set credit limits by customer rather than applying a blanket policy.
- Bill promptly and correctly; a meaningful share of slow payment is usually disputed or missing documentation, not unwillingness.
- Charge interest on past-due balances and enforce it consistently.
Revisit a discount only if the aging shows a broad, healthy customer base that is simply paying late by habit.