Cash Conversion Cycle
Time from payment for raw materials until cash is collected on sales. *
Accounts payable- when should the firm pay
Inventory- How much to hold
Laber and Materials Needed
Finished Goods Inventory- how much needed
Cash collection- how fast do you collect
See exhibit 14.2 on page 86
Cash Conversion Cycle
1.) Operating cycle= days sales in inventory+ Days Sales Outstanding =(Inv/(COGS/365))+(AR/(Credit
Ideally purchases would be used in place of CGS in the DPO calculation What does the operating cycle tell us?
How long your cash is tied up in your goods. From inventory to sales. Cash Conversion cycles
Having trade credit reduces cash conversion cycle
Negative cycle-operating efficiently
Days receivable short, inventory turnover quick
collecting cash before you have to pay bills
WC Investment Strategies
High % of current assets to sales
Large amounts of cash, marketable securities and inventory
Liberal trade creit policy for customers, which results in high levels of accounts receivable Low risk low return
Advantage: Large working capital balances
Disadvantage: High carrying cost
In 2008 it would have been an advangage
Would have had cash to buy things at lower cost
Credit was frozen during crisis.
Current assets are kept to a minimum
Right terms of sale intended to curb credit sales and accounts receivable High-risk-high-return
Disadvantages: shortage costs
Financial; emergency borrowing
Operating; lost production and sales (ex. Emergency inventory) Advantage: lower carrying costs higher returns
AR Management Credit Policy Terms/Costs
Cash sales only; possibility of lost sales
Attracts new customers and reduces DSO
Shorter period reduces DSO and average A/R
May discourage sales
Credit Standards: Tighter standards reduce bad debt losses, buy may reduce sales. Collection Policy: Tougher policy will reduce DSO, but may damage customer relationships.
Trade Credit: Loan from the supplier, usually very costly for of credit Issued with terms 2/10 net 20
Effective annual rate (cost of borrowing)
Breakdown of accounts receibable by their date of sale; how long the account has not been paid in days Identify and track delinquent accounts and to see that they are paid Effective DSO=weighted average DSO
Result of too much inventory High carrying cost
Or lost money if parishables
Not enough inventory
Lost sales or backlogged.
How to know how much inventory to order
Sales forecast, industry average ect…
Inventory management more closely related to operations than to finance EOQ- minimizes costs ordering ahead of time
JIT- order materials as needed
All values are known with certaintiy and costand over time.
Inventory useage is uniform over time
Carying costs change proportionally with changes in inventory levels All ordering costs are fixed
Assumptions do not hold in the “real world”
Substantially reduces carrying costs
Ordering costs are raised by frequent orders
No raw material costs
No obsolete inventory
High Dependence on suppliers!!!
* Cash Management
* Reasons for holding cash
Minimum cash balance
Lower boundary for cash balances
Exchange for the services lenders provide
Collection times (Float) time between when a customer makes a payment and when the cash becomes available to the firm. Delivery time
Delay between the time of the deposit and the time the cash is available for withdrawl.
That can be used towards operations
Important to manage
Need money to pay bills
Need to have working capital for emergency use
Manage costs of inventory and collections.
How to measure effieciency of using working capital...
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