This measure is useful in understanding working capital management and its efficiency
28-Mar-2022 •Arul Selvan
The cash conversion cycle is a unique metric that measures how long it takes for a company to convert its inventory into cash. Obviously, the smaller this number, the better. The cash conversion cycle has three components: inventory days, receivable days and payable days. Inventory days measure the number of days it takes for the company to sell its inventory. Receivable days measure how many days it takes for a company to receive cash from the sales. And payable days measure how many days of credit a company gets from its suppliers. The cash conversion cycle is calculated as inventory days + receivable days - payable days.
Since sales happen mostly on credit, it is crucial to keep a tab on how efficiently the company manages its working capital. If a company can ensure that it can quickly convert its inventory into sales or receive cash earlier or enjoy a liberal credit period from its suppliers, it would not only be in a much better position from a working-capital point of view but would also be more efficient due to lower inventory costs.
Do note that in the case of service providers, inventory days would not be as relevant as they are for a product-based company.
Case in point: Maruti Suzuki
Maruti Suzuki, India's largest car manufacturer, has receivable days of 8.45, whereas its payable days are 63.44 (as of FY21). It indicates that while Maruti is able to realise its cash quickly, it has been squeezing its suppliers by making them wait for about nine weeks.
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