What cash conversion cycle says about a firm – The Financial Express

Clipped from: https://www.financialexpress.com/money/your-money-what-cash-conversion-cycle-says-about-a-firm/2287368/

Cash conversion cycle reveals the days payables adjusted days in getting back the cash that goes out in the operations of a firm

Your Money: What cash conversion cycle says about a firmThe inference rule is higher the DP, better is the efficiency.

Working capital efficiency can be assessed using cash conversion cycle (CCC). Let us look at the computation of CCC along with its inference rule.

Hypothetical illustration
Let us assume the following figures (amount in Rs crore) for Abhijit Dipankar Phanindra Ltd (ADP) for its latest financial year: Current assets 1,200; Trade receivables 600; inventories 400; cash and cash equivalent 100; other current assets 100; current liabilities 800; trade payables 300; accrued expenses 100; current portion of long term debt 150; short term bank loan 150; other current liabilities 100; sales revenue 2000; cost of goods sold 1,200; daily sales 5.48 (2000/365 days); daily cost of goods sold 3.29 (1200/365 days).

Cash Conversion Cycle (CCC)
It is the excess of the operating cycle over the days payables of a firm. Operating cycle is the sum of days receivables and days inventories. While operating cycle reflects the days taken by a firm in getting back its funds tied up in inventories and receivables, CCC reveals the days payables adjusted days in getting back the cash that goes out in the operations of a firm.

Days Inventories (DSI)
It is the number of days a firm stores inventories and is computed by dividing inventories by the daily cost of goods sold (CGS) of a firm. For ADP, it is 122 days (inventories of Rs 400 crore divided by daily CGS of Rs 3.29 crore) for the current year. Lower the days inventories, better is the inventory management efficiency of a firm. If the DSI of ADP was 150 days in the previous year, then the firm has improved its inventory management efficiency in the current year.

Days Receivables (DSO)
It is the number of days a firm takes in collecting its receivables. It is computed by dividing trade receivables by daily sales of a firm. For ADP, it is 109 days (trade receivables of Rs 600 crore divided by daily sales of Rs 5.48crore) for the current year. Lower the average collection period, better is the receivables management efficiency of a firm. If days receivables of ADP were 120 days in the previous year, then the firm has improved its receivables management efficiency in the current year.

Days Payables (DP)
It reveals the number of days taken by a firm in clearing its dues. It is calculated by dividing the trade payables and accrued expenses by daily cost of goods sold (CGS). For ADP, DP is 122 days. This indicates that ADP is taking 122 days to pay its suppliers. If the firm’s DP was 140 days in the previous year, then it has become inefficient in its payables management in the current year.

The inference rule is higher the DP, better is the efficiency.

Cash Conversion Cycle (CCC)
The CCC for ADP is 109 days (DSI of 122 days plus DSO of 109 days minus DP of 122 days) in the current year. It was 130 days (DSI of 150 days plus DSO of 120 days minus DP of 140 days) in the previous year. The firm has taken 109 days for receiving back a rupee that has gone out from its operations in the latest year while it had taken 130 days for the same in the previous year. Hence, the working capital efficiency of the firm has improved in the current year.

The writer is associate professor of Finance at XLRI — Xavier School of Management, Jamshedpur

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