Question

1. Why cash conversion cycle is important to measure company’s liquidity?

2. Why investors focus on ROIC and Debt/Cap Ratio?

3. How do you justify higher Debt/Cap Ratio?

Answer 1

1.

Cash conversion cycle measures the time an entity required to convert cash from amount invested in inventory. When entity increases investment in inventory for increasing sales it has risk of facing low liquidity. So cash conversion cycle estimates the risk involved regarding liquidity due to growth object of the entity. Therefore cash conversion cycle helps to measure the liquidity of the entity as it finds number of days required to convert it's inventory to cash.

2.

ROIC(return on invested capital) shows the percentage of returns that an entity earns on the amount of investment made. If the entity is making good ROIC then the entity need not to borrow money from outside to make additional investment. So this ROIC ratio helps investors to analyse the performance of the entity.

Debt to capital ratio depicts the capital structure of the entity i.e. it represents amount of owner's fund and outsider's funds out of total amount invested. If debt to capital ratio is high then the entity faces difficulties during low sales period as entity needs to pay interest on debt. So investors analyse this before investing in an entity.

3.

High debt capital ratio means the amount of debt invested in the business is high. Debt involves both high risk and as well as high returns.

During high sales period high debt becomes advantage because the entity needs to pay only fixed amount of interest to debt holders, so the amount left to pay it's capital holders will be more.

Where as during low sales period debt becomes disadvantage because paying a fixed amount of interest becomes burden as entity didn't generate sufficient return due to low sales.