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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.

Another old article from William
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Asoneth

Friday 3rd of December 2010

Good article, easy to understand too.

Drizzt

Wednesday 26th of May 2010

its a good thing in the sense that you get your money earlier than your short term borrows. you will have no liquidity problems

Anna

Wednesday 26th of May 2010

is it good or bad when the cash conversion cycle is in a negative?

paul

Tuesday 23rd of September 2008

good article... can you give list of companies who are operating in a negative conversion cycle? and how these companies survive?

drizzt

Tuesday 12th of September 2006

Hi J-Chan, in my opinion, industries which collect cash upfront will have good cash conversion cycle. This would include most retail firms and internet retailers. Amazon comes to mind.

Then, you have those companies that traditionally have a challenge managing good cash cycle due to the traditional way of doing things. however, through innovation, business process reengineering they are able to maximise their efficiency. Walmart and of course Dell comes to mind. They have very low inventory for a business that has a reputation of needing them in the backoffice due to their sales process.

I do hope i can come up with more relevant singapore examples for you J-chan.

Regards,

Drizzt

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