Question

Explain the concept of a firm’s cash conversion cycle. How do financial statement ratios provide insight into a firm’s cash conversion cycle? [

Answer 1

The Cash Conversion Cycle shows the amount of time it takes a company to convert its investments in inventory to cash.The metric takes into account how much time the company needs to sell its inventory, how much time it takes to collect receivables, and how much time it has to pay its bills without incurring penalties.

Cash conversion cycle= Days Inventory Outstanding + Days Sales Outstanding - Days Payable Outstanding

The financial ratios used in calculating the cash conversion cycle are inventory turnover, account receivable turnover and account payable turnover. Higher the ratios, lower will be the days of Outstanding and vice versa. These ratios affect the cash conversion cycle directly.