LDP 4.1 Business Cash Cycles

Question 1

Cash Cycle (the asset conversion cycle)

Answer 1

• The purpose is to show how cash moves throughout a company as its assets and liabilities shrink and expand in a fairly regular pattern.
• Measuring the cash cycle will help you analyze working capital and evaluate whether a company needs a short-term or long-term loan.

Question 2

Long-term borrowing is caused by:

Answer 2

1) A permanent lengthening of the cash cycle (declining inventory)
2) A permanent increase in the amount of cash needed daily (sales growth)

Question 3

Short-term borrowing is caused by:

Answer 3

1) A temporary lengthening of the cash cycle

2) A temporary increase in the amount of daily cash requirements

Question 4

All cash cycle calculations are averages, which can:

Answer 4

• Mask irregularities that are inevitable for all companies.
• Mislead you when analyzing seasonal companies.

Question 5

Businesses that require little investment in current assets:

Answer 5

• Generate revenues without substantial investments in inventories
• Have minimal cash tied up since they sell mostly for cash, use national credit cards, and have short-term billing
• Require short cash cycles and little need for working capital
• Operate using negative working capital

Question 6

Businesses that make a substantial investment in current assets:

Answer 6

• Depend on turning inventory to generate sales
• Offer payment terms to customers
• Have longer cash cycles
• Operates unsuccessfully with negative working capital

Question 7

Cash Cycle Formula (Manufacturer)

Answer 7

Average days’ sales in receivables
+ Average days’ COGS in inventory
– Average days’ purchases in payables
= Average days in cash cycle (using days’ purchases in A/P)

Question 8

Cash Cycle Formula (Others)

Answer 8

Average days’ sales in receivables
+ Average days’ COGS in inventory
– Average days’ COGS in payables
= Average days in cash cycle