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Model for managing and financing current assets
THE CASH CONVERSION CYCLE
Cash conversion cycle (CCC)
Inventory/Sales per day
AR/Sales per day
AP/COGS per day
Chapter 22 deals with working capital management. Two useful tools for working capital management are (1)
the cash conversion cycle and (2) the cash budget.
This spreadsheet model shows how these tools are used to
help manage current assets.
The cash conversion cycle model focuses on the length of time between when the company must make payments and when it
receives cash inflows.
The cash conversion cycle is determined by three factors: (1) The inventory conversion period, which
is the average time required to convert materials into finished goods and then to sell those goods.
The inventory conversion
period is measured by dividing inventory by the average daily sales.
(2) The receivables collection period, which is the
length of time required to convert the firm's receivables into cash, or how long it takes to collect cash from a sale. The
receivables collection period is measured by the days sales outstanding ratio (DSO), which is accounts receivable divided by
average daily sales.
(3) The payables deferral period, which is the average length of time between the purchase of materials
and labor and payment for them.
The payable deferral period is calculated by dividing average accounts payable by
purchases per day (cost of goods sold divided by 360 or 365 days).
The cash conversion cycle is determined by the following
Calculate the cash conversion cycle for the Real Time Computer Company.
Annual sales are $10 million, and the annual
cost of goods sold is $8 million.
The average levels of inventory, receivables, and accounts payable are $2,000,000, $657,534,
and $657,534, respectively. RTCC uses a 365-day accounting year.