Short-term Cash Management: Managing the Cash Conversion Cycle

Pepsi is a multinational company who operates within three primary industry segments:
beverages, snack foods, and restaurants. The primary products sold in the beverage
segment include Pepsi, Diet Pepsi, 7UP, and ountain Dew. !rito"#ay represents the
domestic snack food business, while Pepsi$o%s restaurant segment consists primarily of
Taco &ell, Pi''a (ut, and )entucky !ried $hicken *)!$+. Pepsi also engages in several ,oint
ventures around the world, each within one of the three industry segments.
&ecause Pepsi is such a large manufacturer and distributor, they spend millions of dollars
each year on salaries trying to keep track of orders, payments, and receipts for each of their
three lines of business.
Todd -ovelstad, a manager in !inancial .ervices at Pepsi%s Phoeni/ plant, has discovered a
way to reduce the time re0uired to log orders, payments, and receipts. (is idea is simple, yet
innovative. Todd uses bar codes to sort paperwork. 1ust as bar codes are used in a grocery
store to identify each item and its price, Todd can use bar codes to identify where orders are
sent to and from, the product that is being referred to, and the amount of the product to be
bought, sold, or shipped.
This idea has several positive attributes. !irst, the Pepsi employees will be able to do their
logging up to four times faster than they are able to under the current system. Today,
receipts for payment are left stacked until a processor can get to them. This also allows
employees to concentrate more on other ways in which the company can save money.
.econd, the accuracy rate under the bar code system is 22.223. 4hile keying in codes is
relatively accurate also, Pepsi has been e/periencing problems because their workers are
putting in too much over time and fatigue has increased the error rate.
Todd did not stop at bar codes for processing accounts receivables. (e also saw the
usefulness of bar codes for mail. The post office now sorts mail electronically by bar codes
for those letters that have them. Pepsi can use coded envelopes to speed up the return time
when its customers pay for shipments. These funds can then be deposited into Pepsi$o%s
account much sooner than they currently can be. 5ven though interest is earned on only one
to two additional days, when considering the si'e of Pepsi, this will translates into big
savings.
Pepsi wants to determine ,ust how much these new programs will save the company. To
determine the amount, they have disclosed the following information concerning the
operating cycle. Pepsi%s average payment period is 62 days. Their average age of inventory
is 76 days.
8nd the average collection period is 92 days.
Pepsi feels that with the new system in place, it can speed up the average collection period
by :6 days. This figure reflects the fact that the employees will not only receive the
payments earlier, but more importantly, they will be able to start processing the receipts
much sooner than they are currently able to do. The average age of the inventory and
average payment period are assumed to remain unchanged.
Pepsi currently spends ;6<,===,=== per year on its operating cycle investments. !unds used
for financing the operating cycle cost :63 per annum. Todd feels the additional annual cost
of ;>=,=== will be sufficient to pay for the added hardware necessary to use bar codes. This
e/pense does not take into consideration the additional salary e/penses that will be avoided
due to a reduction in overtime costs.
Questions
1. $alculate Pepsi%s current operating cycle, cash conversion cycle, and need for shortterm
financing of the cash conversion cycle *i.e. 4hat is Pepsi%s negotiated financing need?+.
2. $alculate the operating cycle, cash conversion cycle, and need for short"term
financing of the cash conversion cycle if Pepsi decides to implement the use of bar
codes.
3. @f the bar codes are used in the future, what will be the annual savings stemming
specifically from the cash conversion cycle financing reduction?
4. $onsidering the annual costs associated with implementing the bar code system,
should Pepsi change their logging systems?
5. 8ssume the cost of implementing the bar code system e/ceeds the savings in
reduction of short"term financing needs. .hould Pepsi decide not to change systems?
Discuss.
6. Define the cash conversion cycle and e/plain why it is so important. Do you think cash
conversion cycles should be different for different industries *(@AT " consider a
manufacturer versus a retailer+.
7. 4hat are the three ways to speed up the cash conversion cycle?