A cash conversion cycle approach to liquidity analysis final
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A Cash Conversion Cycle Approach To Liquidity
Analysis
Group DAkriti Bajracharya
Ayusha BajracharyaBimash SharmaNancy ShresthaNischal Gautam
Umesh Maharjan
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Outline of the presentation
1.Brief introduction
2.Objective of the article
3.Methodology used
4.Findings of the article
5.Conclusion
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Introduction
• Verlyn D Richards (Professor of Finance) and Eugene J. Laughlin (Professor of Accounting).
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Objective
• Focus on the different approaches, such as traditional approach and the operating cycle concept for the liquidity analysis of the firm, as well as their drawbacks
• Comparison between traditional balance sheet ratios and comprehensive approach to analysis
• To clear out the misinterpretation made by the static liquidity analysis
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Methodology
Descriptive
analysis
Uses of secondary data
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Findings
• Current ratio and acid-test ratio
Static Liquidity Analysis
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• Current Ratio
• Ignores the qualitative differences in liquidity attributes of current assets.
• Responded to the problem by introduction of more restrictive acid test ratio.
• Both static liquidity indicators is limited by their failure to provide adequate information about cash flow attributes of the transformation process within a firm’s working capital position.
• Emphasize essentially liquidation, rather than a going concern approach to liquidity analysis.
Misinterpretation of liquidity position
Current ratio
Acid –test ratio
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Operating cycle
Receivable collection period
Inventory holding period
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• High receivable & longer collection period longer operating cycle deteriorating liquidity.
• High receivable high current and acid-test ratio improving liquidity.
• Similar in case of inventory.• Drawback do not consider the
liquidity requirement imposed by current liabilities.
Incorrect analysis of liquidity position
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Liquidity Management
Cash
Raw material inventory
Finished goods inventory
Receivables
Cash
con
vers
ion
cycl
e
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• Different from operating cycle concept
Considers cash outflow requirement in an analysis
• Cash conversion cycle interpretation of liquidity position Impact of longer operating cycle Impact of longer payable deferral period
• Interpretation opposite to static liquidity analysis.
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Financial management implication
• Spontaneous and non-spontaneous financing
SpontaneousNon-spontaneous
Working Capital Investment
The need for cash conversion cycle approach
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• Length of cash conversion cycle has impact on Financial structure Investment structure
Length of cash conversion cycle
Borrowing capacity
In case of economic uncertainty
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Conclusion
Static liquidity analysis
Operating cycle concept
Cash conversion cycle concept
Liquidity Analysis
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THANK YOU
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Any Questions ??