Page 29 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes
Example: Continuing the same example, this time “Hilal Widgets Co.” has an accounts
payable balance of ` 4,56,000 at the end of the year. The result is an accounts payable days of 55.5
(` 4,56,000 / ` 30,00,000 ) x 365 = 55.5 days
In the case of Hilal Widget Co. the Cash Conversion Cycle is 31 days. (36.5 + 50 – 55.5)

2.3.2 Significance of Cash Cycle

This cycle is extremely important for retailers and similar businesses. This measure illustrates
how quickly a company can convert its products into cash through sales. The shorter the cycle,
the less time capital is tied up in the business process, and thus the better for the company’s
bottom line.
Cash Cycle is an important analysis tool that allows the credit analyst to determine more easily
why and when the business needs more cash to operate, and when and how it will be able to
repay the cash. It is also used to distinguish between the customer’s stated loan purpose and the
borrowing cause. Once the cash conversion cycle for the borrower is mapped, the analyst is able
to judge whether the purpose, repayment source and structure of the loan are the adequate ones.
Managing asset conversion in favor of the business owner is the ultimate goal of transportation
logistics and techniques such as just in time inventory.
The length of the cash cycle dictates the amount of money that needs to be tied up in working
capital proportionate to sales.
A shorter cash conversion cycle is better, other things being equal. It is possible for the cash
conversion cycle to be negative, this is most likely for certain retailers who buy on credit, sell
for cash and have a high stock turnover.

Example: Below is a numerical example of this calculation:

For demonstration purposes, we have steadily held the payables processing period at 72 days. It
is clear from the above example that the firm’s financial condition, from the perspective of the
cash conversion cycle, has improved. Inventory processing and accounts receivable turnover
has improved for firm A from year one to year three, implying that the processing period of
each has declined.

24 LOVELY PROFESSIONAL UNIVERSITY