cash conversion cycle

Examples of cash conversion cycle in the following topics:

• Short-Term Approach

  • The most widely used measure of cash flow is the net operating cycle or cash conversion cycle.
  • The cash conversion cycle indicates the firm's ability to convert its resources into cash and informs management of the liquidity risk entailed by growth .
  • Because this number effectively corresponds to the time that the firm's cash is tied up in operations and unavailable for other activities, management generally aims at shortening the cash conversion cycle as much as possible.
  • The aim of the study and calculation of the cash conversion cycle is to change the policies relating to credit purchase and credit sales.
  • A firm can change its standards for payment on credit purchases and getting payment from debtors on the basis of cash conversion cycle.

• Defining the Cash Flow Cycle

  • The cash flow cycle measures how long it takes for a firm to recover cash that it invests in ongoing operations.
  • Cash flow cycle also is called "cash conversion cycle" (CCC).
  • The cash conversion cycle refers to the time frame between a firm's cash disbursement and cash collection.
  • Although the term "cash conversion cycle" technically applies to a firm in any industry, the equation is formulated to apply specifically to a retailer.
  • The CCC must be calculated by tracing a change in cash through its effect upon receivables, inventory, payables, and finally back to cash, thus, the term cash conversion cycle, and the observation that these four accounts "articulate" with one another.

• Calculating the Cash Flow Cycle

  • The cash flow cycle is also called cash conversion cycle (CCC).
  • The Cash Conversion Cycle emerges as interval C→D (i.e., disbursing cash→collecting cash).
  • The operating cycle emerges as interval A→D (i.e., owing cash→collecting cash)
  • We can change our standard of payment of credit purchase or getting cash from our debtors on the basis of reports of cash conversion cycle.
  • Cash flow statement and cash conversion cycle study will be helpful for cash flow analysis.

• Decision Criteria

  • That is, working capital is the difference between resources in cash or readily convertible into cash (current assets), and cash requirements (current liabilities).
  • One measure of cash flow is provided by the cash conversion cycle—the net number of days from the outlay of cash for raw material to receiving payment from the customer.
  • It includes buying of raw materials and selling of finished goods either in cash or on credit.
  • This affects the cash conversion cycle.
  • Cash conversion cycle is a main criteria for working capital management.

• Identifying Varying Conditions

  • Management uses policies and techniques for the management of working capital such as cash, inventory, debtors and short term financing.
  • The policies aim at managing the current assets (generally cash and cash equivalents, inventories and debtors) and the short-term financing, such that cash flows and returns are acceptable.
  • Identify the cash balance that allows for the business to meet day-to-day expenses, but reduces cash holding costs.
  • Identify the appropriate credit policy (i.e., credit terms which will attract customers such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence return on capital or vice versa).
  • Identify the appropriate source of financing, given the cash conversion cycle.

• Choosing a Policy

  • A firm will use a combination of policies for managing working capital, focusing on cash flow, liquidity, profitability, and capital return.
  • These policies aim to manage the current assets - generally, cash and cash equivalents, inventories and debtors - and the short term financing, such that cash flows and returns are acceptable.
  • In order to effectively manage cash flow, a firm should identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs - i.e., the opportunity cost of holding cash as opposed to investing it.
  • Management should identify the appropriate credit policy so that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and return on capital.
  • A firm should identify the appropriate source of financing, given the cash conversion cycle.

• Working Capital

  • The management of working capital involves managing inventories, accounts receivable and payable, and cash.
  • Debtors' management involves identifying the appropriate credit policies, i.e. credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence, return on capital.
  • Short-term financing requires identifying the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan (or overdraft).
  • Cash management involves identifying the cash balance which allows for the business to meet day-to-day expenses, but reduces cash holding costs.
  • The management of working capital involves managing inventories, accounts receivable and payable, and cash.

• Evaluating Interest Rates

  • Management of working capital requires evaluating factors affecting cash flows -- including the evaluation of appropriate interest rates.
  • These decisions are, therefore, based primarily on profitability, cash flows and their management.
  • Thus, working capital policies aim at managing the current assets (generally cash and cash equivalents, inventories and debtors) and the short term financing, such that cash flows and returns are acceptable.
  • Debtors management involves identifying the appropriate credit policy -- i.e. credit terms which will attract customers -- such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and, hence, return on capital (or vice versa).
  • Short-term financing involves identifying the appropriate source of financing, given the cash conversion cycle.

• Controlling the Components of Working Capital

  • Cash management: Identify the cash balance that allows the business to meet day to day expenses, but reduces cash holding costs.
  • Cash is a CA.
  • Inventory management: Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials--and minimizes reordering costs--and hence increases cash flow.
  • Debtors management: Identify the appropriate credit policy, such as credit terms, that will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa).
  • Short-term financing (as well as long-term financing that comes due in the next year or operating cycle) is a CL.

• Payments

  • Cash payments describe cash flowing out of a business.
  • The cash disbursement cycle is important to consider when analyzing cash payments.
  • A company's objective regarding the cash disbursement cycle should be to increase the cycle time, or delay making payments until they are due.
  • This will increase the mail time, or mail float, within the disbursement cycle.
  • Therefore, when a company manages cash flow cycles, it tries to control three types of float times: