Cash conversion cycle tells the period in which we collect our cash if we invest our money in inventory and then we sell it on credit. If cash conversion cycle is positive, it means, we have more time for collecting money from inventory and credit sales than payment to creditors. At that time, we have to maintain other sources of cash for our operation of business. If cash conversion cycle is negative, it means, we can collect money more quickly from our inventory and credit sales than payment to our creditors. At that time, we can take decision to invest this money in other projects.
Following is the simple formula for calculation of cash conversion cycle or period
= Inventory conversion period + Receivables conversion period – Payables conversion period
or
= 365 / inventory turnover ratio + 365 / debtors turnover ratio - 365/ creditors turnover ratio
Following is example which explain this concept
Actually cash conversion period is nothing but it is the part of whole cycle which is created with inventory, debtor and creditor conversion cycle.
Both days payable outstanding and days sales outstanding will tell you the exact position of cash conversion period. Our aim of studying cash conversion cycle and its calculation is to change the policies relating to credit purchase and credit sales. We can change our standard of payment of credit purchase or getting cash from our debtors on the basis of reports of cash conversion cycle. If it tells good cash liquidity position, we can maintain our past credit policies. Its also aim is to study cash flow of business. Cash flow statement and cash conversion cycle study will be helpful for cash flow analysis.
Following is the simple formula for calculation of cash conversion cycle or period
= Inventory conversion period + Receivables conversion period – Payables conversion period
or
= 365 / inventory turnover ratio + 365 / debtors turnover ratio - 365/ creditors turnover ratio
Following is example which explain this concept
Actually cash conversion period is nothing but it is the part of whole cycle which is created with inventory, debtor and creditor conversion cycle.
Both days payable outstanding and days sales outstanding will tell you the exact position of cash conversion period. Our aim of studying cash conversion cycle and its calculation is to change the policies relating to credit purchase and credit sales. We can change our standard of payment of credit purchase or getting cash from our debtors on the basis of reports of cash conversion cycle. If it tells good cash liquidity position, we can maintain our past credit policies. Its also aim is to study cash flow of business. Cash flow statement and cash conversion cycle study will be helpful for cash flow analysis.
Comments