Introduction to Corporate Finance

ONLINE CHAPTERS

A positive cash conversion cycle means that trade credit (credit granted to a company by its suppliers)

does not provide enough financing to cover the company’s entire operating cycle. In that case, the

company must seek other forms of financing, such as bank lines of credit and term loans. However,

the costs of these financing sources tend to be higher than the costs of trade credit. Thus, the company

benefits by finding ways to shorten its operating cycle or to lengthen its payment period. Actions that

accomplish these objectives include the following:

1 Turn over inventory as quickly as possible while avoiding stockouts that result in lost sales.

2 Collect accounts receivable as quickly as possible without losing sales because of high-pressure

collection techniques.

3 Pay accounts as slowly as possible without damaging the company’s credit rating, its relationships with

suppliers or paying burdensome late fees.

4 Reduce mail, processing and clearing time when collecting from customers, but increase them when

paying vendors.

Techniques for implementing the first two actions are the focus of the remainder of this chapter.

Chapter 19 focuses on actions 3 and 4.

CONCEPT REVIEW QUESTIONS 18-1

1 What does a company’s cash conversion cycle represent? Explain the financial manager’s goal with

regard to the CCC.

2 How should a company manage its inventory, accounts receivable and accounts payable in order to

reduce the length of its cash conversion cycle?

finance in practice

LESS KINGLY CASH PLUMBS THE DEBTS

Organisations are very conscious of the need to

evaluate their inventory measurements on their own;

but it also helps them to see what their competitors

are doing. The Hackett Group conducts a regular

survey of US companies around the world, and

publishes its results. The latest available data,

from 2015, make for some disturbing reading. The

report’s opening is given below.

The cash conversion cycle (CCC) once again

remained flat in 2014, only improving one

day since 2007. Cash on hand continued

to increase, improving a total 74% over the

same period. Even though revenue has

increased 39%, debt continues to be a source

of investment, increasing an alarming total

62% over the same period. Companies that

increased their debt 100% or more since 2007

had a 1,516% increase in cash on hand but

their CCC worsened by 113%. The companies

that decreased their debt since 2007 had

a 336% increase in cash on hand but their

CCC improved 31%. There is a $1 trillion cash

flow opportunity comparing top and bottom

performers with the most in Inventory and

Payables.