You are developing a business plan for a new wholesale specialty goods retailer. You collect data on typical industry working capital terms. Industry credit terms to customer are 20 days and average inventory days on hand is 30. Suppliers grant wholesalers credit for an average of 15 days. You estimate that adopting the industry terms would produce $3 million of annual revenue. Cost of goods sold will be 70% of revenue. You are considering alternative terms, including offering new customers 45 days to pay, which will increase revenue by 20% to $3.6 million. A new just-in-time inventory system which includes shipments directly from manufacturers to retailers will reduce inventory days on hand to 25. Finally, to establish strong ties with your suppliers, you will keep accounts payable at 10 days.
a. Using the industry data, compute the cash cycle and estimate the investment in working capital the business would require.
b. Using the alternative terms, compute the cash cycle and estimate the investment in working capital the business would require. What are the pros and cons of the alternative terms?