Question

he cash conversion cycle (CCC) is a metric that illustrates the amount of time it takes a firm to convert investments within their inventory into cash. The cash conversion cycle formula calculates the amount of time, in days, it takes for a company to turn its resource inputs into cash.

The cash conversion cycle formula is: CCC = DIO + DSO – DPO

• Discuss the benefits the company stands to gain by accurately determining the cash conversion cycle (CCC).
• Discuss how an increase in the DPO will impact the cash conversion cycle?

Answer 1

1] In the formula, CCC = DIO + DSO – DPO,

DIO = Days inventory outstanding, DSO = Days sales outstanding and DPO = Days payables outstanding.

Advantages of accurately determining the CCC:

*It facilitates arrangement of finance for the working capital

*It enables measures to be taken to reduce the DSO and DIO or increase the DPO in order to reduce the CCC.

*Impact of decisions relating to receivables management and inventory management can be highlighted in terms of increase or decrease in CCC and resultant net benefits.

2] Discuss how an increase in the DPO will impact the cash conversion cycle?

An increase in DPO will reduce the CCC as CCC = DIO + DSO – DPO. However, DPO cannot be increased beyond a point as it would affect the firm's relationship with its suppliers. Too much stretching of DPO will result in suppliers snapping arrangements or increasing prices for supplies. These reactions may result in increase of DIO.