The Treasurer’s Guide to Trade Finance

Common calculations

This figure shows that on average the

company pays its suppliers in 84 days. This

figure needs to be measured against the

company’s previous DPO figures and, where

possible, against DPO measurements of the

company’s main competitors.

In general terms, the higher the DPO,

the better for the company, as it suggests

the company is able to hold onto its cash

for longer. There are many reasons why a

company’s DPO may change in an economic

cycle. For example, a relatively high DPO may

suggest the company’s procurement team has

been able to negotiate better payment terms

with its suppliers. On the other hand, it may

also suggest difficulties in realising the cash to

meet payment obligations.

A relatively low DPO may suggest

suppliers have reduced their willingness

to offer credit to the company or it may

suggest suppliers are offering discounts for

early payment.

The treasurer will want to identify the

reasons behind any changes in the DPO over

time. Any suggestion that suppliers are facing

difficulties will need investigation and may

warrant action being taken to support the

supply chain.

Days inventory outstanding

DIO measures the efficiency of a company’s

production process. It is also referred to

as the inventory period, the days sales of

inventory or stock turnover.

This is calculated by using the following

equation:

DIO = [average inventory / cost of goods

sold in period (excluding VAT or sales

taxes)] × number of days in period

So, consider a company with an average

USD 16.5 million inventory with annual sales

of USD 55 million:

DIO = (16,500,000 / 55,000,000) × 365

= 109.5 days

This figure shows the company holds

inventory for, on average, just under 110

days. It needs to be measured against the

company’s previous DIO figures and, where

possible, against DIO measurements of the

company’s main competitors. The DIO figures

will vary significantly from industry to industry.

For example, manufacturers of large items,

such as aeroplanes, will expect to have

higher DIO measurements than retailers.

In general terms, the DIO measurement

is of most use as a comparison with

previous figures. A rising DIO indicates a

weakening in the market’s appetite for a

company’s product, as it suggests goods

are sitting longer in the warehouse. A falling

DIO is most likely to indicate an increase

in demand for the company’s products or

an improvement in the efficiency of the

company’s production process.

However, if the company cuts production

levels in response to a previous weakening

in demand, this will also lead to a fall in DIO.

Therefore the treasurer should ensure the

reasons behind any change in DIO are fully

understood.

When using DIO there will always be

a compromise between the need to hold

sufficient inventory so as to be able to meet

sales requests, with all the associated

storage costs and the impact on working

capital, and selling inventory as quickly as

possible to free up cash.

Cash conversion cycle

The cash conversion cycle uses these

three concepts to measure the company’s

efficiency in turning inputs into cash. It is

calculated using the following equation:

CCC = DIO + DSO – DPO

Consider a company with a DSO of 46.2 days,

a DPO of 83.6 days and a DIO of 109.5 days:

CCC = 109.5 + 46.2 – 83.6 = 72.1 days

This figure suggests it takes the company

just over 72 days to purchase its raw

materials and convert them into cash. This is

also the minimum working capital financing

which will be required, as it represents the

point between the cash going to the supplier

and being received from the customer.

In order to minimise the level of external

funding the company needs to arrange, it

needs to try to reduce the CCC figure. This

can be done by:

ƒ agreeing extended credit terms with its

suppliers, increasing DPO;