The Cash Conversion Cycle refers to the number of days that there are between disbursing cash and collecting cash in connection with undertaking a discrete unit of operations. This can be shown as either of the calculations below:
Inventory conversion period + Receivables conversion period - Payables conversion period.
Avg. Inventory / (COGS / 365) + Avg. Accounts Receivable / (Credit Sales / 365) - Avg. Accounts Payable / (COGS / 365).
Although the Cash Conversion Cycle can be used in any firm or industry, these equations are formulated to apply specifically to a retailer. As the retailer's operations consist of buying and selling inventory, the equations can be used to model the time between disbursing cash to satisfy the accounts payable created by the sale of the unit of the inventory and collecting the cash to satisfy the accounts receivable generated by that sale. The equation is also written accommodate a firm that buys and sells on account. A firm's Cash Conversion Cycle must be derived from Statement of Financial Position data associated with the firm's operations as it cannot be directly observed from cash flows. This is because these cash flows are also influenced by investment and financing activities.
The Cash Conversion Cycle is used in management accounting to calculate the liquidity risk caused by growth in a firm. This is done by measuring the length of time that a firm will be deprived of cash if it increases its investment in resources that will expand its customer sales. Shortening the Cash Conversion Cycle creates risks as a firm could achieve a negative Cash Conversion Cycle by collecting money from customers before they have paid the suppliers. It is not always sustainable to keep a policy of strict collections and lax payments within a firm.
Inventory conversion period + Receivables conversion period - Payables conversion period.
Avg. Inventory / (COGS / 365) + Avg. Accounts Receivable / (Credit Sales / 365) - Avg. Accounts Payable / (COGS / 365).
Although the Cash Conversion Cycle can be used in any firm or industry, these equations are formulated to apply specifically to a retailer. As the retailer's operations consist of buying and selling inventory, the equations can be used to model the time between disbursing cash to satisfy the accounts payable created by the sale of the unit of the inventory and collecting the cash to satisfy the accounts receivable generated by that sale. The equation is also written accommodate a firm that buys and sells on account. A firm's Cash Conversion Cycle must be derived from Statement of Financial Position data associated with the firm's operations as it cannot be directly observed from cash flows. This is because these cash flows are also influenced by investment and financing activities.
The Cash Conversion Cycle is used in management accounting to calculate the liquidity risk caused by growth in a firm. This is done by measuring the length of time that a firm will be deprived of cash if it increases its investment in resources that will expand its customer sales. Shortening the Cash Conversion Cycle creates risks as a firm could achieve a negative Cash Conversion Cycle by collecting money from customers before they have paid the suppliers. It is not always sustainable to keep a policy of strict collections and lax payments within a firm.
