Question

Florida Distributors have a high cash conversion cycle (CCC); 47 days compared to industry average of 25 days.

a) What would you recommend to this company to shorten its cash conversion cycle (CCC)?

b) How is reduction in CCC going to effect the profitability of this company?

c) Florida Distributors tries to match the maturity of its assets and liabilities. Describe how this company could adopt a more aggressive or a more conservative financing policy.

Answer 1

The cash conversion cycle comprises of (Receivable Days + Inventory Days) - Payable Days.

1. Florida distributors will be advised to reduce its receivable days and inventory days and increase its payable days to reduce the CCC.
2. Reducing the inventory days helps the company to lower the cash required to be paid for purchases and that cash can be used for other profitable activities. Reduction in receivable days may lead to lower sales which will reduce the profitability of the company. Increasing the payable days may result in higher costs to the company which will reduce the profitability of the company.
3. Matching the maturity of assets and liabilities is a good conservative financing policy. Ideally, long-term assets should only be financed by the long term liabilities and short-term assets with short term liabilities. The company can be more conservative in financing policy by deploying long-term sources of funds for short-term uses which helps the company to safeguard itself from any short-term shocks in the market cycle.