Question

As a board member of Bronson Inc., your SVP-Accounting has recently presented the details of a five-year study of the firm’s cash conversion cycle, ironically, the period of time the SVP has been in charge. The executive summary spreadsheet outlines the following (where ICP = inventory conversion period, ACP = average collection period, PDP = payables deferral period, and AVE = industry average).

ICP ACP PDP CCC AVE
2015 48 34 42 40 59
2014 51 39 30 60 58
2013 41 31 53 19 53
2012 38 25 58 5 62
2011 31 21 56 -4 51

What are your questions, compliments, concerns, and recommendations?

Answer 1

Cash Conversion Cycle (CCC) is the period of time between the purchase of raw material, converting the same into inventory, selling the inventory and collecting receivables in lieu of credit sales. The shorter this time period is, the greater is the firm's efficiency in managing cash at hand, thereby making lower CCC values desirable. As deferred payables/accounts payable is considered as a source of cash, the same is deducted from the firm's normal operating cycle (ICP + ACP) to arrive at the CCC. For the company mentioned in this problem:

CCC 2011 = ACP + ICP - PDP = 31+21-56 = - 4 and Industry Average = 51

A negative CCC value implies that suppliers are paid after collection is received from customers, thereby effectively financing the firm's short-term capital needs through deferred payables. The industry average is much higher at 51, which implies that the average firm in the Industry requires 51 days of short-term financing.

The firm's CCC keeps increasing up to 2014 where it becomes equal to the industry average for the first time. This happens because the firm takes progressively more time to sell inventory and collect receivables (as is indicated by the increasing ICP and ACP) all the while facing tighter credit durations as is reflected in the progressively shorter PDP. In 2015 the firm reverses the trend which witnesses its CCC going below the Industry average again.