B2 - Cash convertion cycle

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CASH CONVERTION CYCLE


The Balance Sheet (BS) is the consequence, in financial terms, of what and HOW we do things in the company.

• The BS does not come out of the blue but rather shows our decisions regarding business design, how well/bad (efficiently/inefficently) we manage our company and the current environment.

• Lets take a look at how operations are reflected in our BS.

Our operations commence with the purchasing of raw materials and other elements necessary for the production phase; we usually keep raw materials in stock for this purpose (for 15 days in our example).


Time

Raw material

purchases

Sale to customer

15 days 10 days 20 days

Storage, production and stock


The production process starts at a specific moment (lasting for another 10 days in our example).


Time

Raw material

purchases

Sale to customer




The production process starts at a specific moment (lasting for another 10 days in our example).

Once the process has been completed, the finished goods are kept for, lets say, another 20 days until the product is sold to the customer.


Time

Raw material

purchases

Sale to customer




Time

Raw material

purchases

Storage, production and stock45 d

Sale to customer

The sale is cashed

Collection period60 d

Once the finished good is sold, the invoice is issued and the product is sent to the customer. But even if the sale is completed, we do not receive the cash until the agreed day (in our example, after 60 days).


Time

Raw material

purchases


Sale to customer

The sale is cashed


Days State15 days As raw materials10 days In production phase20 days In finished goods store60 days Collection period agreed with the

customer

Total: 105 days

Once the finished good is sold, the invoice is issued and the product is sent to the customer. But even if the sale is completed, we do not receive the cash until the agreed day (in our example, after 60 days).

Adding up the days from the purchase of raw materials to the cash collection day gives the following:


Time

Raw material

purchases


Sale to customer

The sale is cashed


Payment to the supplier

Payment period75 d

Fortunately, we also have a few days to pay suppliers (agreed payment period). Let us assume 75 days as an agreed term for payment to the supplier.


Time

Raw material

purchases


Sale to customer

The sale is cashed



Payment period75 d Time to be financed

30 d

In our example, we will pay the supplier on day 75 and collect on day 105. Therefore, we will need funds to finance 30 days:


Time

Raw material

purchases


Sale to customer

The sale is cashed



Payment period75 d Time to be financed

30 d

Days State of nature15 days As raw materials10 days In production phase20 days In finish goods store60 days Collection period agreed with the

customer

Total: 105 days Minus: 75 days Agreed payment periodNet: 30 days Of operations that the company needs

funds for financing

In our example, we will pay the supplier on day 75 and collect on day 105. Therefore, we will need funds to finance 30 days:


In our Balance Sheet, the consequences of the aforementioned transactions would be:

• Once we have reached continuity in our operations, the company will maintain the following (in stock) in its warehouse:– Raw materials; – Very possibly work in progress (WIP) in the

production phase; – Finished goods waiting to be sold; – Debtor balances (or account receivables)

from different customers; and also– Creditor balances (or account payables)

waiting to be paid to suppliers and other creditors.

• On top of that, the company needs to keep some cash in hand and in banks in order to:– cover the differences between payment

days and collection days, – Cover uncertainties, etc.

Cash

Customer(and other accounts

receivible)

Stocks(or Inventories)

Suppliers and other Accounts

Payable

B2 - Cash convertion cycle

Business

Transcript of B2 - Cash convertion cycle