Introduction
With the rise in globalization pressures, it has become necessary for businesses to expand their operational activities and serve more targeted audience or population to capture more market share. Additionally, businesses do this activity to create more shareholder wealth as wealth. In this regard, one of the biggest challenges which financial managers come across is the maintenance of the liquidity position of the business. It is important to every organization to keep itself liquid to keep its credit and counterparty risk to a sustainable level .
One of core concepts in this situation is the investigation into the Cash Conversion Cycle (CCC) demonstrates the operational efficiency by analyzing the time period during which a business generates sales, collects cash from clients and repay its short-term creditors . The higher the CCC, greater will be the ability to generate enough cash inflow stream to remain liquid . Therefore, this paper is written to assist financial managers in calculation of a Cash Conversion Cycle (CCC) by considering three efficiency ratios which will be presented in Parts I and II. Different calculations are performed using three efficiency ratios formulae for which are mentioned in the appendix section.
Part-1
Firm’s Cash Conversion Cycle
In order to compute the cash conversion cycle for the firm, the following table is considered which reflects the results obtained after performing calculations through formulas presented in Appendix 1:
The above table indicates that this particular firm is able to turn its inventories to sales in a period of seventy eight days. However, to maintain its liquidity, this business collects cash due to its customers, against credit sales, in thirty six days but has the policy to repay the trade credit or short-term debt to its creditors or vendors in fifty two days. Overall, the company is able to complete the cash generation cycle within sixty business days. In other words, the firm collect cash, sell its inventories and repay is short-maturity debt within a period of sixty days.
In order to improve the Cash Conversion Cycle (CCC), it is necessary to compare the current figure to either those for previous years (intra-firm comparison) or these financial results could be compared to those for industry competition (inter-firm or industry-wide comparison). With figures relating to just one year, one may not be able to compare the results and comment whether the firm is efficient enough or not. However, theoretically, the management is advised to maintain the efficiency of Cash Conversion Cycle (CCC) by shortening the period during which cash is generated through selling of inventories and collecting credit from clients. The firm can have the accounts payable payment period as long as possible to pay creditors within a year which is beneficial for the liquidity strength of the firm .
Part-II
Firm’s Cash Conversion Cycle
Accounts Receivable Investment
Based on a given assumption of the firm having all of its sales generated on a credit basis, the amount of accounts receivables is calculated using the following information for which the calculation is mentioned in the appendices section of this research paper:
Turning Over the Inventory in a Year
Conclusion
References
Anonymous. (2012). The Cash Conversion Cycle. Retrieved December 18, 2014, from Forbes: http://www.forbes.com/sites/ycharts/2012/03/10/the-cash-conversion-cycle/
Besley, S., & Brigham, E. (2007). Essentials of Managerial Finance. Cengage Learning.
Lewis, J. (n.d). How Can a Company Shorten Its Cash Cycle? Retrieved December 18, 2014, from The Houston Chronicle: http://smallbusiness.chron.com/can-company-shorten-its-cash-cycle-37755.html
Meggitt, J. (n.d). How Is Our Delayed Billing Affecting the Cash-Conversion Cycle? Retrieved December 18, 2014, from The Houston Chronicle: http://smallbusiness.chron.com/delayed-billing-affecting-cashconversion-cycle-39094.html
Robinson, T. R., Henry, E., Pirie, W. L., & Broihahn, M. A. (2012). International Financial Statement Analysis. John Wiley & Sons.
Appendices
Appendix 1 - Formulas
A. Inventory Turnover (In Days) = (Inventories / Cost of Goods Sold) * 365
B. Receivable Turnover (In Days) = (Receivables / Credit Sales Revenue) * 365
C. Account Payable Turnover (In Days) = (Payables / Cost of Goods Sold) * 365
D. Cash Conversion Cycle (CCC in Days) = (A + B) - C = D
Appendix 2 – Calculation of Accounts Receivable Investment
The calculation is performed by using the receivable turnover formula and rearranging it in the following manner to calculate the amount of receivables:
Receivable Turnover = (Receivables / Net Credit Sales) × Business Days in A Year
29 = (Receivables / $4 million) × 365
Receivables = (29 / 365) × $4 million = $0.318 million
