Page 261 - DMGT207_MANAGEMENT_OF_FINANCES

Management of Finances

Notes relations. The latter activity has assumed increased importance in markets where share
price performance is regarded as crucial and may affect the company's ability to undertake
acquisition activity or, if the price falls drastically, the lender it vulnerable to a hostile bid.

Self Assessment

Fill in the blanks:
11. Treasury will normally manage ……………… funds in an investment portfolio.
12. Treasury advise on the ………………to be used when invoicing overseas sales.

11.7 The Cash Conversion Cycle

Central to short-term financial management is an understanding of the term 'Cash Conversion
Cycle'.
We have discussed in the earlier unit that operating cycle encompasses two major short-term
asset categories: inventory and accounts receivable. It is measured by summing the average age
of inventories and average collection period.

However, the process of producing and selling a product also includes purchase of production
inputs (raw materials) an account, which results in accounts payables. Accounts payable reduce
the number of days a firm's resources are tied up in operating cycle. The time it takes to pay the
accounts payable, measured in days is the average payment period.

Did u know? What is cash conversion cycle?
The operating cycle less the average payment period is referred as the Cash Conversion
Cycle. It represents the amount of time the firms' resources are tied up.

Example: MAX Company, a producer of paper has annual sale of 10 lakhs, a cost of
goods sold of 75% of sales, and purchases are 65% of cost of goods sold. MAX has an average age
of inventory of 60 days, an average collection period of 40 days and an average payment period
of 35 days. Thus, the cash conversion cycle for MAX is 65 days (60 + 40 – 35).

Funding Requirements of the Cash Conversion Cycle

Permanent versus seasonal funding needs: If the firm's sales are constant, then its investment in
operating assets should also be constant, and the firm will have only a permanent funding
requirement. If the firms' sales are cyclic, then its investment in operating assets will vary over
time with its sales cycles and the firm will have seasonal funding requirements in addition to
the permanent funding required for its minimum investment in operating assets.

Aggressive versus Conservative Seasonal Funding Strategies

1. Short-term funds are typically less expensive than long-term funds. Long-term funds
allow the firm to lock in the funds over a period of time and thus avoid the risk of
increases in short-term interest.
2. Long-term funding ensures that the required funds are available to the firm when needed.

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