cash conversion cycle

What is Cash Conversion Cycle?

Cash Conversion cycle is a process which shows how fast company can convert accounts receivables and sales back to cash and cash into inventory and accounts payable. Cash management involves following steps –

  1. Flow of cash into and out of the firm.
  2. Inflow of cash within the firm.
  3. Cash balances held by the firm  at a point of time by financing deficit or investing surplus cash.

Cash conversion cycle represents these activities. Sales generate cash which need to be invested. Surplus cash is invested back and deficit has to be borrowed. Cash management seeks that cash conversion cycle establishes this at a minimum cost. At the same time, company also tries to achieve liquidity and control. Management of cash than other current assets as cash is the most significant but least productive short term asset that the firm holds.

Unlike long term assets or inventories, it does not results in producing goods for sale. Therefore, the aim of the cash management is to maintain adequate control over cash position to keep the firm sufficiently liquid and to use the excess cash in some profitable way.

It is also important to manage cash as it is difficult to predict the cash flows accurately. There are times when cash outflows exceeds cash inflows. Further, it is important because cash constitutes the small portion of the total current assets.

Facets of Cash Management

Four facets of cash management are as follows –

Cash Planning

Cash inflows and outflows should be planned to project cash surplus or deficit  for each period of the planning period. For this purpose, cash budget should be prepared.

Optimum Cash Level

Organisation must decide the appropriate level of cash balances. Both excess cash and insufficient cash is not good for the firm. So, it should decide the optimum level of cash to be maintained.

Managing the cash flows

There should be proper management of cash. The inflow of cash should be accelerated while cash out flows should be decelerated.

Investment of surplus cash

The surplus cash should be invested to earn profits. The firm should decide about the division of such cash balance between alternative short term opportunities.