Page 28 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 2: Planning of Working Capital

cash from customers and also considering how many days it can take to pay suppliers, it is Notes
possible to get an idea of how comfortable a company’s cash flow position is.

2.3.1 Meaning of Cash Cycle

The cash cycle, also called the Cash Conversion Cycle (CCC), is a measure of the length of time
it takes to get from paying cash for stock to getting cash after selling it. It is equal to:
Stock days + Debtor days – Creditor days
In other terms it may also be said that the Cash Cycle (CC) is a metric that expresses the length
of time, in days, that it takes for a company to convert resource inputs into cash flows. The cash
conversion cycle attempts to measure the amount of time each net input dollar is tied up in the
production and sales process before it is converted into cash through sales to customers. This
metric looks at the amount of time needed to sell inventory, the amount of time needed to
collect receivables and the length of time the company is afforded to pay its bills without
incurring penalties.
Cash Conversion Cycle is calculated as:
CCC = DIO + DSO – DPO
Where:
DIO represents days inventory outstanding
DSO represents days sales outstanding
DPO represents days payable outstanding
Let us understand each of these terms one by one.
DSO: It also represents accounts receivable turnover in days and measures the average number
of days from the sale of goods to collection of resulting receivables. It is obtained by the
following formula:
(Accounts Receivable/Sales × 365).

Example: A manufacturer of widgets: “Hilal Widget Co.” with annual sales of ` 50,00,000
and with accounts receivable outstanding of ` 5,00,000 at the end of the year is said to have a 36.5
DIO.
= (` 5,00,000/` 50,00,000 ) × 365 = 36.5 days

DIO: It also represents inventory turnover and measures the length of time on average between
acquisition and sale of merchandise. For a manufacturer it covers the amount of time between
purchase of raw material and sale of the completed product. It is obtained by the following
formula:
(Inventory/COGS × 365)

Example: Going back to our example of widget manufacturer “Hilal Widget Co.”, let’s
suppose that the company had a COGS of ` 30,00,000 with inventory of ` 4,11,000 at the end of the
year. It would be said that Hilal Widget Co. has inventory turnover days of 50.
(` 4,11,000/` 30,00,000) × 365 = 50 days

DPO: It also represents payables turnover in days and measures the average length of time
between purchase of goods and payment for them. It is obtained by the following formula:
(Accounts Payable/COGS × 365)

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