Question

Consider the operating cycle to answer the following questions.

Operating Cycle

cash-- settle payables -- Account Payable-- purchases -- Buy with payables-- inventories -- sales-- accounts receivable -- returned to cash -- (Again the cycle repeat) --- Cash

1. Why might a company want to reduce its cash conversion cycle? (Hint: Consider the financial statement implications of reducing the cash conversion cycle.)
2. How might a company reduce its cash conversion cycle?
3. Examine and discuss the potential impacts on customers and suppliers of taking the actions

Answer 1

A company want to reduce its cash conversion cycle because it will have the ample liquidity in its hands when it will reduce the cash conversion cycle and it will have lesser of the Liquidity risk.

Having a huge amount of cash in its hands, means that company will be not suffer wuth opportunity loss due to its capital getting struck and it will have ample opportunities to invest in multiple projects because it will have cash in its hands, and it will also not default on various debt payments.

A company can reduce is cash conversion cycle by-

A. Reducing the account payables days so that the debtors are realised early.

B. Extending the creditors payable days, so it will have the flexibility of paying its creditors later and having reduced cash conversion cycle

C. Having more of the marketable securities and cash and cash equivalents in its books of accounts.

There would be adequate repercussion of reducing the cash conversion cycle because there would be a motivation towards such debtors by providing various discount schemes and upfront payment schemes to motivate them to pay them before the the due date, so that the company is always ahead in its cash conversion cycle and there would also be a higher rate of interest which can be provided to its creditors in order to to reduce its cash conversion cycle by lagging the payments.