What is the cash flow/conversion cycle?
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What is the cash flow/conversion cycle? How is it possible for an organization to be profitable but out of cash? What are some ways that an organization can speed up its collection of cash?
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Solution Summary
This solution explains cash flow and conversion cycles, and how it's possible for organizations to be profitable but out of cash.
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Firm can be profitable but its out of cash due to following reasons:
Cash flow is recorded the transaction when cash is exchanged, whereas accrual indicators record a financial flow at the time economic value is created, transformed, exchanged, transferred or extinguished, whether or not cash is exchanged at the time. Thus there can be higher profits due to accrued income.
Cash conversion cycle is difference between operating cycle (or gross operating cycle) and the payment deferral period (or the period for which creditors remain outstanding). It indicates how much cash investment firm requires for day to day operations.
Cash Conversion Cycle (CCC) = Operating Cycle (OC) - Payables Deferral Period,
Operating Cycle (OC) = Inventory Conversion Period + Receivables Conversion Period
Thus extending the credit or greater investment in the accounts receivable and reduction in the accounts payable will increase working capital requirement and cash conversion period.
Increase in inventory costs will increase the working capital needs and ...
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