Cash conversion cycle
From Free net encyclopedia
Cash conversion cycle, also known as asset conversion cycle, net operating cycle, working capital cycle or just cash cycle, is a figure used in the financial analysis of a business. The higher the number, the longer a firm's money is tied up in operations of the business and unavailable for other activities such as investing. The cash conversion cycle is the number of days between paying for raw materials and receiving the cash from the sale of the goods made from that raw material.
Cash Conversion Cycle = Average Stockholding Period (in days) + Average Receivables Processing Period (in days) – Average Payables Processing Period (in days)
with
Average Stockholding Period (in days) = Closing Stock / Average Daily Purchases.
Average Receivables Processing Period (in days) = Accounts Receivables / Average Daily Credit Sales.
Average Payable Processing Period (in days) = Accounts Payables / Average Daily Credit Purchases.
A short cash conversion cycle is a sign of good working capital management. Conversely, a long cash conversion cycle indicates that capital is tied up while the business waits for customers to pay.
It is quite possible for a business to have a negative cash conversion cycle, i.e. receiving payment from customers before it has to pay suppliers. Examples are typically companies which employ Just In Time practices such as Dell, and companies which buy on extended credit terms and sell for cash, such as Tesco.