The cash conversion cycle is used to analyze the financial aspects of a business. The higher the number, the longer the company's money is tied up in operations of the business, therefore the cash not be used for other financial activities The cash conversion cycle is the actual number of days between paying for raw materials and receiving the actual cash from the sale of the goods. The following formulas are used to calculate the cash cycle:
* Cash Conversion Cycle = Average Stockholding Period (in days) + Average Receivables Processing Period (in days) - Average Payables Processing Period (in days)
* Average Stockholding Period (in days) = Closing Stock / Average Daily Purchases
* Average Receivables Processing Period (in days) = Accounts Receivable / Average Daily Credit Sales
* Average Payable Processing Period (in days) = Accounts Payable / Average Daily Credit Purchases
An excellent sign of working capital is a short cash conversion cycle.
A long cash conversion cycle indicates that the capital is being tied up too long. The business may be suffering while awaiting payments from its customers.
A business can have a negative cash conversion cycle. For example, if a company receives a payment from customers before it has to pay suppliers, this could create a negative cash cycle. If a company has a longer production process, the more cash the firm must keep tied up in inventories. On the other hand, the longer it takes customers to pay, the higher the dollar amount accounts receivable. Xtreme should a discount as an incentive for those you pay on time or early. Xtreme could also find a way to delay its payments. If a company can postpone paying for its raw materials, it may reduce the amount of cash the company needs.
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