CP

(16-2)

Thus, it takes 24 days after a sale to convert the receivables into cash.

3.Payables deferral period, which is the average length of time between the pur-

chase of materials and labor and the payment of cash for them. For example, if the

firm on average has 30 days to pay for labor and materials, if its cost of goods sold

is $8 million per year, and if its accounts payable average $657,534, then its

payables deferral period can be calculated as follows:

(16-3)

30 days.

The calculated figure is consistent with the stated 30-day payment period.^3

4.Cash conversion cycle, which nets out the three periods just defined and which

therefore equals the length of time between the firm’s actual cash expenditures to

pay for productive resources (materials and labor) and its own cash receipts from

the sale of products (that is, the length of time between paying for labor and mate-

rials and collecting on receivables). The cash conversion cycle thus equals the aver-

age length of time a dollar is tied up in current assets.

We can now use these definitions to analyze the cash conversion cycle. First, the

concept is diagrammed in Figure 16-1. Each component is given a number, and the

cash conversion cycle can be expressed by this equation:

(1)  (2)  (3) 
 (4)

(16-4)

To illustrate, suppose it takes Real Time an average of 73 days to convert raw mate-

rials to computers and then to sell them, and another 24 days to collect on re-

ceivables. However, 30 days normally elapse between receipt of raw materials and

payment for them. Therefore, the cash conversion cycle would be 67 days:

Days in cash conversion cycle 
73 days 24 days 30 days 
67 days.

To look at it another way,

Cash inflow delay Payment delay
Net delay

(73 days 24 days)  30 days 
67 days.

Inventory

conversion

period



Receivables

collection

period



Payables

deferral

period

Cash

conversion

cycle

.

$657,534

$8,000,000/365

Payables

Cost of goods sold/365

Payables

deferral

period

Payables

Purchases per day

$657,534

$10,000,000/365

24 days.

Receivables

collection period


DSO


Receivables

Sales/365

(^3) Some sources define the payables deferral period as payables divided by daily sales.
The Cash Conversion Cycle 583

578 Working Capital Management