Business
Cash Conversion Cycle
The Cash Conversion Cycle (CCC) measures the time it takes for a company to convert its investments in inventory and other resources into cash flow from sales. It encompasses the period from when cash is spent on production inputs to when the cash is collected from the sale of the resulting products. A shorter CCC indicates better liquidity and efficiency in managing working capital.
Written by Perlego with AI-assistance
Related key terms
1 of 5
6 Key excerpts on "Cash Conversion Cycle"
eBook - PDF- Robert Parrino, David S. Kidwell, Thomas Bates(Authors)
- 2016(Publication Date)
- Wiley(Publisher)
Use as little labour and other inputs to the production process as possible while maintaining product quality. LEARNING OBJECTIVE 2 Cash Conversion Cycle The length of time from the point at which a company pays for raw materials until the point at which it receives cash from the sale of finished goods made from those materials. 14.2 The Operating and Cash Conversion Cycles 473 Maintain the level of finished goods inventories that represents the best trade-off between minimising the amount of capital invested in finished goods inventories and the desire to avoid lost sales. Offer customers terms on trade credit that are sufficiently attractive to support sales and yet minimise the cost of this credit, both the financing cost and the risk of non-payment. Collect cash payments on accounts receivable as quickly as possible to close the loop. All of these goals have implications for the firm’s efficiency and liquidity. It is the financial manager’s responsibility to ensure that he or she makes decisions that maximise the value of the firm. Managing the length of the Cash Conversion Cycle is one aspect of managing working capital to maximise the value of the firm. 3 Next, we discuss two simple tools to measure working capital efficiency. As you read the discussion, refer to Exhibit 14.3. Operating Cycle The operating cycle starts with the receipt of raw materials and ends with the collection of cash from customers for the sale of finished goods made from those materials. The operating cycle can be described in terms of two components: days’ sales in inventory and days’ sales outstand-ing. The formulas for these efficiency ratios were developed in Chapter 4. Apple’s ratios and the average industry standard ratios are shown in Exhibit 14.4.
eBook - ePub- (Author)
- 2023(Publication Date)
- Wiley(Publisher)
Issuers invest cash to generate revenues and profits. The Cash Conversion Cycle is the length of time from paying suppliers to collecting cash from customers.The Cash Conversion Cycle is measured as the sum of days of inventory on hand and days sales outstanding, less days payable outstanding. A short Cash Conversion Cycle means that an issuer converts an investment in inventory into cash quickly, while a long Cash Conversion Cycle means that an issuer converts its inventory investments into cash slowly.- Collecting cash from customers sooner, delaying payments to suppliers, and reducing inventory levels relative to sales improve an issuer’s Cash Conversion Cycle.
Working capital is defined as an issuer’s short-term assets minus its short-term liabilities. Net working capital adjusts for non-operating accounts such as cash, marketable securities, and short-term debt. The ratio of net working capital to sales is closely related to an issuer’s Cash Conversion Cycle a long Cash Conversion Cycle is associated with higher net working capital to sales, while a short Cash Conversion Cycle is associated with lower net working capital to sales.An issuer’s liquidity is primarily determined by the relative amounts and liquidity of its short-term assets and liabilities, which are determined by the issuer’s business model. The long-run primary source of liquidity for most issuers is cash flow from operations. Secondary sources of liquidity are typically used in crises and impose significant costs, such as issuing equity, renegotiating contracts, selling assets, and filing for bankruptcy protection.Drags and pulls on liquidity affect an issuer’s liquidity situation. Drags on liquidity reduce cash inflows and include such issues as uncollectible receivables and obsolete inventory. Pulls on liquidity are accelerations in cash outflows or interruptions in credit.
eBook - ePub- Laurie L. Burney, Mary A. Malina, Laurie L. Burney, Mary A. Malina(Authors)
- 2019(Publication Date)
- Emerald Publishing Limited(Publisher)
The purpose of this research study is to use a large sample of the US companies and investigate the impact of cash-to-cash cycle’s (C2C) length on company profitability and liquidity in present and future periods and also examine whether such impact is dependent upon firm size or industry type. The authors investigate the association between C2C length and return on equity (ROE), as well as liquidity ratios for current and future years using linear regression models. The authors further examine such association for separate industries and explore the effect of size on the primary associations investigated. Consistent with prior literature, this study documents that C2C length is negatively (positively) associated with current profitability (liquidity). The authors also find that there is a significant negative association between C2C length and future profitability extending up to three years, but only for firms in the manufacturing industry. This research study shows that C2C length affects a firm’s current financial performance and managers should view C2C management as an important strategic tool. However, the authors caution that C2C management is not a “one size fits all” strategy and managers in smaller firms should pay close attention to their C2C cycle. The authors also show that firms in manufacturing industry will specifically benefit financially over long-term from C2C management. This article complements existing literature that examines the impact of working capital management on a firm’s financial performance and extends the literature by examining such relationship for different industries and firm sizes. Although the authors include various factors (e.g., firm size, leverage, growth, industry, year, and past performance) in regressions to control for observable differences among firms, there might be other unobservable differences that may have an effect on the results documented.Keywords: Cash Conversion Cycle; C2C length; profitability; liquidity; working capital management; financial supply chain managementINTRODUCTION
The purpose of this research study is to investigate the long-term impact of the length of the cash-to-cash (C2C) cycle, a financial supply chain management (FSCM) tool, on a company’s profitability and liquidity.1 The C2C cycle is dependent upon the turnover of inventory, accounts receivable, and accounts payable. Firms may turn over their inventory and accounts receivable faster while delaying their payment to suppliers to reduce C2C cycle length. In general, as finance theory suggests, firms with longer C2C cycles are more likely to have larger investment in working capital. Money locked up in working capital may necessitate additional financing through borrowings or other sources (Deloff, 2003 ), thereby increasing the overall cost of capital. Based on this conventional wisdom and finance theory, prior literature generally suggests that there is an association between a company’s C2C length and its current year profitability and liquidity (Eljelly, 2004 ; Soenen, 1993 ; Wertheim & Robinson, 1993
eBook - ePub- Rob Reider(Author)
- 2014(Publication Date)
- Business Expert Press(Publisher)
CHAPTER 3 Cash Conversion You are in the cash conversion business to create desired goods and services so that the investment in the business is as quickly converted to cash as possible, with the resultant cash-in exceeding the cash-out (net profits or positive return on investment).
Cash Conversion BasicsKNOW THE BUSINESS YOU ARE IN, FOR THE WRONG BUSINESS MAY DO YOU IN One of the businesses that every business is in is the cash conversion business , which creates an emphasis on• obtaining quality sales that result in timely cash collections that provide for a desired profit after deducting all relevant costs such as product or service, functional (such as purchasing and accounting), and customer costs;• collecting cash on sales as quickly as possible through cash advances or upfront cash payments, payment at the time of shipment or customer receipt, effective use of Electronic Funds Transfer (EFT), and price adjustments for customers who desire to pay within a shorter collection period;• effective vendor negotiations that ensure lowest possible prices while still guaranteeing 100 percent quality and on-time deliveries;• procedures for ensuring that materials and supplies are not ordered, received, and paid for until absolutely necessary;• continual program to reduce all costs that are unnecessary or of a nonvalue-added nature that provide no add-on value to the product or service;In this manner, the cash conversion process becomes a tool to maintain the business in the most economical, efficient, and effective manner possible. In establishing operating controls that monitor the previously listed goals, the business must keep in mind those operational areas that effect cash-in and cash-out. With these principles in mind, operations can be analyzed to identify areas for improvement in which best practices can be implemented that maximize cash inflow and minimize cash outflow.
eBook - PDFIntroduction to Finance
Markets, Investments, and Financial Management
- Ronald W. Melicher, Edgar A. Norton(Authors)
- 2020(Publication Date)
- Wiley(Publisher)
Cash Conversion Cycle time between a firm’s paying its suppliers for inventory and collecting cash from customers on a sale of the finished product Table 15.1 Selected Financial Data for Walgreens ($ millions) 2018 Revenue $131,537 Cost of goods sold $100,745 Accounts receivable $7,144 Inventories $10,976 Accounts payable $14,660 15.2 Operating and Cash Conversion Cycles 471 As an alternative calculation, we can divide the 2018 year-end inventories amount by the 2018 cost of goods sold (COGS) per day. In ratio form, we have the following: Inventory conversion period Inventory COGS Inventory COG / 365 S per day $ $ $ $ 10 976 100 745 365 10 976 276 01 39 8 , , / , . . days It took about 39.8 days in 2018 for Walgreens to complete the inventory conversion period. 15.2.3.2 Accounts Receivable Period The second step is to determine the average collection period in 2018 for Walgreens. We saw this ratio in Chapter 14. It measures the average time between when a product is sold on credit and cash is received from the buyer. It is calculated as follows: Average collection period Accounts receivable Net sales / 365 $ $ $ $ 7 144 131 537 365 7 144 360 38 19 8 , , / , . . days During 2018, Walgreens needed an average of 19.8 days from the time finished goods were sold on credit to when the resulting receivables were collected. The operating cycle is determined as follows: Operating cycle Inventory conversion period Average collec tion period Walgreens’ average 2018 operating cycle was 39.8 days to process and sell its inventory plus 19.8 days to collect its receivables for a total of 59.6 days. 15.2.3.3 Average Payment Period The average payment period represents the time it takes Walgreens to pay its suppliers. We were first introduced to this ratio in Chapter 14. The average payment period is calculated by dividing a firm’s accounts payable by its cost of goods sold per day.
eBook - PDF- William D. Bygrave, Andrew Zacharakis, Sean Wise(Authors)
- 2015(Publication Date)
- Wiley(Publisher)
The accounts receivable cycle then begins with the sale and concludes with the collection of the receivable. During this operating cycle, the business generally receives some credit from suppliers. The accounts payable cycle begins with the purchase of the raw materials or finished goods, but it ends with the payment to the supplier. The vast majority of organizations, par- ticularly manufacturing operations, experience a gap between the time when they have to pay suppliers and the time when they receive payment from customers. This gap is known as the Cash Conversion Cycle (CCC). For most companies, the credit provided by suppliers ends Negative Cash Conversion Cycle In 2000, a second-year college student by the name of Siamak Taghaddos set up a new venture, Grasshopper, that provided emerging growth compa- nies with a professional telephone-answering service. Virtually all Taghaddos’s sales were generated through an automated system that he created on the Internet. Customers paid upfront monthly fees ranging from $9.95 to $39.95 that were charged automatically to their credit cards. Taghaddos paid his own expenses a few weeks later. This negative Cash Conversion Cycle enabled him to grow exponentially with little need for external capital (since he initially leased the equip- ment required for the service). By his final year, Taghaddos was generating over $500,000 in revenues and outearned all but a handful of his professors. Two years after his graduation, he had rev- enues over $5 million and 20 employees and was named, along with his partner David Hauser, by Businessweek as one of the top five entrepreneurs in the United States under the age of 25. Although this successful entrepre- neur clearly generated the majority of his growth based on unique skill and marketing insight, had he not estab- lished a company with a negative Cash Conversion Cycle it’s likely that his meteoric growth would have been constrained because of a severe cash crunch.
Index pages curate the most relevant extracts from our library of academic textbooks. They’ve been created using an in-house natural language model (NLM), each adding context and meaning to key research topics.
