CASH CYCLE AND CASH TURNOVERS
Cash Cycle refers to the amount of time that elapses from the point when the firm makes a cash outlay to purchase raw materials to the point when cash is collected from the sale of finished goods produced using those raw materials.
Cash turnover on the other hand refers to the frequency of a firm’s cash cycle during a year.
Illustration
XYZ Ltd. currently purchases all its raw materials on credit and sells its merchandise on credit. The credit terms extended to the firm currently requires payment within thirty days of a purchase while the firm currently requires its customers to pay within sixty days of a sale. However, the firm on average takes 35 days to pay its accounts payable and the average collection period is 70 days. On average, 85 days elapse between the point a raw material is purchased and the point the finished goods are sold.
Required
Determine the cash conversion cycle and the cash turnover.
Solution
The following chart can help further understand the question:
Inventory Conversion period (85 days)
Receivable collection
Period (70 days)
The cash conversion cycle is given by the following formula:
Cash conversion = Inventory conversion + Receivable collection – Payable deferral
Cycle period period period
For our example:
Cash conversion cycle = 85 + 70 – 35 = 120 days
Cash turnover = 360
Cash conversion cycle
=
= 3 times
Note also that cash conversion cycle can be given by the following formulae:
Cash conversion cycle =
NB: In this chapter we shall assume that a year has 360 days.