managerial finance
Ramanaraj
replies.docx
Cash conversion cycle
The cash conversion cycle (CCC) is a metric that communicates the timeframe (in days) that it takes for an organization to change over its interests in stock and different assets into money streams from deals. For a successful run, the company management should ensure enough funds during the budget allocation to procure the raw material and produce the finished good to sell. The other important aspect will be liquidity, where the company assets which can be easily encashed through the product life cycle. Based upon the product life cycle and the sales, the generated cash determines the overall health of the company by projecting the trend that cash that is generated from the deliverables.
cash conversion cycle (CCC) = No. of sales (in days) + available inventory to sell (in days) – payables left (in days)
Example: company A bought the raw material for $30,000 and will pay back in a month period (30 days). Now the raw material is stored, and the number of outstanding days left to store is 20. The company should sell as much as they can to generate cash from the deliverables to pay the amount. The days required to sell the goods be 10. Now the remaining days left to pay back be 12 days. So, the cash conversion value is calculated as: - 30+10-12 = 28.
Inventory management
Any kind of company has its own kind of inventory management method. All the raw material procured are updated as per type and kind of specifications using the ERP software. For a product-based company, I work for Lippert Components utilizes the DX 365. The demand and sales are managed and sorted as per the delivery timeline. To organize, schedule and deliver the finished good, the required amount is pre-estimated and planned during the budget allocation meeting. The inventory management is very crucial for a company to keep a track of the raw materials stored within the production facility. Based upon the demand, and the idea to new product introduction into the market may require additional funds. The lenders will provide the loan to the certain amount required, to produce and sell the good to earn the profit. The inventory is also managed in a way to reduce the product that is staying within the facility by appropriate scheduling of the production and sale. If not acted as per the demand and sale, it will increase additional holding cost instead of selling and gaining the profit.
Role of cash conversion cycle and inventory management in informing decision making:
In the business arena, capital management is an important aspect and it enables the company to analyze its current assets and liabilities to meet the cash flow obligations and to maintain all business expenditures effectively. To achieve goals and objectives of capital management cash conversion cycle and inventory management are considered two essential topics. In addition, these two topics help the company to make informed decisions that are related to capital management. Considering the inventory management, it enables the company to store and track the product-related inventories to manage the company sales effectively. Inventory management assists the company to boost up the informing decisions because it provides a complete picture of facts on purchased and existing good so that sales management related decisions will be proposed accordingly (Ahmed, 2016). For example, if the car battery supplier was planned to supply 3000 batteries per year so supplier needs to maintain inventory details to sell the batteries in monthly wise to reach the target. In this way, inventory management assists the company to make informed decisions to manage the cash flows.
On the other hand, Cash Conversion Cycle (CCC) is an important concept to evaluate how a company is able to convert investments into inventory and it also measures the returns or cash collected from the consumers. To make effective informing decisions related to the cash flow management or capital management, CCC has been playing a significant role because it measures the days required for making the conversion of cash into inventory before the sales. This means that the sales process highly relies on the CCC results (Preve & Sarria-Allende, 2010). In fact, CCC provides factors and figures to understand how the company obtains it returns from the customers including the required time period to receive cash from customers also measured by the CCC. To calculate the CCC, it is essential to have Days inventory outstanding (DIO), Days sales outstanding (DPO), and Days payables outstanding (DPO). CCC will be calculated with the help of the equation as follows; DIO+DSO-DPO (Das, 2015). For example, Company A and Company B belong to the same industry and A has its DIO, DSO, and DPO is 20 days, 46 days, and 27 days respectively. So with the help of equation, the CCC of A will be 39 days approximately. In addition, Company B has its DIO, DSO, and DPO is 55 days, 44 days, and 33 days respectively and CCC of 66 days. by comparing CCC results of both companies, it is concluded that company A will convert its cash into inventory and get back its returns from customer sooner than the Company B. this means that company A is better than the company B in terms of cash conversion life cycle. In this way, the CCC concept helps the company to make capital management decisions.
Impacts of Working Capital
It is imperative that a financial manager or an organization adopt a sound fiscal management policies and procedure to improve or to help stabilize any unforeseen contingencies that will cause the organization an economic loss or burden. Financial managers also should know and understand that current assets and liabilities contributes to how people responds to the company’s stock and how well the organization is doing. This chapter we are working on introduce the additional funds needed (AFN) concept to help us understand working capital management (Brigham, et al., 2016)
Cash Conversion Cycle
The cash conversion cycle is a metric used to measure the effectiveness and efficiency of a company's management. It is also used to measure the overall health of that company. The calculation measures how fast a company can convert cash on hand into inventory and accounts payable, through sales and accounts receivable, and then back into cash. A company can have a negative or positive cash conversion cycle and that should concern every manager to ensure that the organization assets and cash conversation is positive by utilizing the metric calculation themselves (Investopedia, n.d.)
Example:
When Bisas first started operation, we realized that there is a shortage of dry Chili Pepper on the market during the month of October until December We were told by the Ghanaian Chili pepper farmers that it is the month of lack of rain which most of the farmers in this business relay on. There is no mechanize farming so everyone will have to wait until the weather turns to be favorable with rains. At this point, Bisa has not started its own farming so, our finance manager decided to buy a lot more of the dry Chili to help our production during this dry season. It was realized that we have spent most of the organization Cash into buying dry Chili Pepper and because we are the only company in this business of processing raw chili pepper into powder, the market did not feel our impact causing our conversion to be very difficult (Laureate, et al., 2015). This cause over three months of unpaid salary to workers because difficulty in converting our inventory into cash even though the opposite is much quicker and faster.
Cash Budget
A cash budget is a budget or plan of expected cash receipts and disbursements during a stipulated period of operation. These cash inflows and outflows include revenues collected, expenses paid, and loans receipts and payments. In other words, a cash budget is an estimated projection of the company's cash position in the future (Miles, et al., 1980). This will allow the financial manager to be able to make an inform decision on proper allocation of resources and information data to analyze organizational strength and weaknesses and determine what the consequences will be if not rectify.
Example:
Bisa Chili Pepper started with a cash budget of five hundred thousand dollars. Upon the purchase of all capital equipment for operations all the way to our first supply of our products to the wholesalers, it was import for our financial manager to make sure that all our receipt for inventory delivery to customer on (IOU) to be accounted for (Lambert, et al., 2007). A company by the name Blow Chem, place a purchase order to $10,000.00, and our carrier and warehouse manager forgot to record the purchase order. At the end of the month, the company realized that our initial inventory count was more than the Sales that came in for the month until it was later disclosed by Blow Chem to us through a check mailed to our purchasing department for the same amount of inventory cash conversion that was missing. Our proposed budget for the quarter included the inventory missing which affected our proposed budget projection for the quarter and the year at large.
