The role of the cash conversion cycle in assessing firms

Cash Conversion Cycle in assessing firms

Cash Conversion Cycle (CCC) can be used to assess the efficiency of working capital. A computation of CCC along with its inference rule is given here. 

Hypothetical illustration

It is assumed that the following figures (amount in Rs crore) are applicable for Abhijit Dipankar Phanindra Ltd. (ADP) for its last financial year:  Current assets 1,200; Trade receivables 600; Inventories 400; Cash and equivalent 100; other current assets 100; current liabilities 800; trade payables 300; accumulated 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; daily cost of goods sold 3.29. The role of the cash conversion cycle in assessing firms

Cash Conversion Cycle (CCC)

CCC is the excess of the operating cycle over the day’s payables of a company. The operating cycle is cumulative of days receivables and days inventories. The CCC reveals the day’s payables adjusted days in getting back the cash that leaves the operations of a firm whereas the operating cycle reflects the days taken by a firm in earning back its funds tied up in inventories and receivables.

Days Inventories (DSI)

DSI is the number of days a firm store’s inventories. It is computed by dividing inventories by the daily cost of goods sold (COGS) of a firm. For ADP, it is found to be  122 days for this current year. Lower days inventories are a sign of better inventory management efficiency of a firm. 

Days Receivables (DSO)

DSO is the number of days a firm takes in gathering its receivables. It is computed by dividing trade receivables by daily sales of a company. It is calculated to be 109 days for ADP for the current financial year. The lower average collection period accounts for better receivable management efficiency.

Days Payables (DP)

DP reveals the number of days taken by a firm to clear its dues. It is calculated by dividing the trade payables and accrued expenses by the daily cost of goods sold. The days payable for ADP is 122 days which indicates that the firm takes 122 days to pay its suppliers. The higher the DP, the better is the efficiency of the firm.

The Cash Conversion Cycle for ADP is calculated to be 109 days in the current year whatever was 130 days in the previous year. This shows that the working capital efficiency of the firm has improved in the current year.

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