Cash Conversion Cycle

Among the many things I look at when we look at short term assets is cash as well as it’s cash conversion cycle.

Cash is the oxygen of the company. some companies are able to create cash due to a variety of reasons. Among them that stands out most is the firm’s business model as well as its management.

We will look at the Cash Conversion Cycle.When a business announces its billing policy or its way it purchase its raw materials, watch it. A company has financial advantages the sooner it recieves payment for products and the later it pays bills. Amazon is an example that receives cash upfront and doesn’t need to pay its suppliers for another 30 days. Therefore, its operations is actually finance by its suppliers.

When a company is paid for sales before it pays for the product it sells, it has much more financial flexibility. This is called having a negative cash conversion cycle. A cash conversion cycle shows the number of days that it takes a firm to turn a dollar paid for inventory into a dollar of income.

Days inventories outstanding – determine no of days it takes to run through inventory.

	Company A	Company B
i) Cost of goods sold	9536	5037
ii) COGS per day (i/365)	26	13.8
iii) Inventories	2992	2741
iv) Days inventories outstanding (iii/ii)	115 days	198 days

Days sales outstanding – determine no of days it takes for company to receive payment after a sale.

	Company A	Company B
i) Revenue	33004	32259
ii) Revenue per day (i/365)	90.4	88.3
iii) Accts Receivable	4630	5337
iv) Days sales outstanding (iii/ii)	51 days	60 days

Days payable outstanding – to get the cash conversion cycle, subtract number of days it takes for a company to pay a product it receive.

	Company A	Company B
i) Cost of goods sold	9536	5037
ii) COGS per day (i/365)	26	13.8
iii) Accounts Payable	2838	1579
iv) Days payable outstanding (iii/ii)	109 days	114 days

A cash conversion cycle: 115 + 51 + (109) = 57 days

B cash conversion cycle: 198 + 60 + (114) = 114 days

Thus, A can turn to cash much better than B. the economics of some business model makes it advantagous for the firm. REtailers are paid upfront by shoppers. You can find many models (most famous being Dell) that will have negative cash cycles. There are some industries which traditionally have such but it is those that exist in an industry that traditionally is hard to get that but still manages to achieve that that excites investors.

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Kyith

Kyith is the Owner and Sole Writer behind Investment Moats. Readers tune in to Investment Moats to learn and build stronger, firmer wealth foundations, how to have a Passive investment strategy, know more about investing in REITs and the nuts and bolts of Active Investing.

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Kyith worked as an IT operations engineer from 2004 to 2019. Currently, he works as a Senior Solutions Specialist in Insurance Start-up Havend. All opinions on Investment Moats are his own and does not represent the views of Providend.

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