Video: Cash Conversion Cycle Exercise for CFA Exam
Video: Cash Conversion Cycle Exercise for CFA Exam
Question:
If a company has cash conversion cycle of 81 days, the account receivable conversion period increased from 30 days to 32 days and the account payable turnover changed from 20 to 21, what is the new cash conversion cycle?
Answer:
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Firstly, you must understand the cash conversion cycle is the time between you pay the cash for the cost of the product and you receive the cash for that product you sold. After a product is made and put into inventory, it will take “Payable Conversion Period” (days) to pay cash for the cost of the production. Of course, after the product is made, it will take “Inventory Conversion Period” (days) to sell the products. After the product is sold, it will take “Receivable Conversion Period” (days) to get the cash payment. Therefore,
Cash Conversion Cycle
= Inventory Conversion Period
+ Receivable Conversion Period
- Payable Conversion Period
Notice that it is “minus” for Payable Conversion Period.
Now, there are more definitions, the conversion periods are just 365 days / their corresponding turnovers. And their turnovers are:
Inventory: COGS/Average Inventory
Receivable: Revenue/Average Account Receivable
Payable: COGS/Average Account Payable
So for this question, we can assume the inventory conversion period is constant as the change was not given. The cash conversion cycle will increase by 2 days due to the change of the receivable conversion period (30 to 32 days). Payable Conversion Period will change from: 365/20 (18.25 days) to 365/21 (17.38 days). So, it will change the cash conversion cycle by –(17.38-18.25) = 0.87 days.
So the new cash conversion cycle will be 81+2+0.87 = 83.87 days.
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What ?? Man, what in the morld are you talking about ? It makes absolutely no sense… how is it related to the cash conversion cycle ? Site operators: please restrict use of the comments option of your site !!!
I thought Inventory conversion is COGS/ Ave. Inventory. The video said its Inventory/COGS??