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Cash Conversion is a quantity that measures the profits a company is making. The profits can readily contribute to cash flow. Cash flow is known as the total amount of money (also cash equivalents) which is transferred in and out of the company. Hence, we can say that cash flow affects the liquid assets of the company. Cash Conversion cycle tells about a company’s effectiveness and is similar to working capital.
Cash conversion cycle tells about the company’s liabilities and short term assets for generating cash. It considers or work on different factors including
the cost of products (sold);
Inventories;
Accounts receivable and Accounts payable (before and after a selected period of time);
a specific period (say one year).
In short, cash conversion cycle is the total number of days it takes from buying the raw materials to selling the finished products.
Less is the value of cash conversion cycle, more is the chance to produce and sell things, which eventually leads to profit. It shows the business health in clear words or numbers. This is generally considered to provide a more accurate report of cash flow than working capital.
For startups, cash conversion cycle is measured in four sections as follows:
The total number of days a customer takes to return whatever he owes to the company (Account Receivable).
The total number of days the company takes in the complete manufacturing of a product or successfully providing its service.
The total number of days the product has stayed as an inventory before eventually being sold out.
The total number of days the company takes to return whatever it owes to other entities in the selected period of time (Account Payable).
Formula,
Cash conversion cycle = (1+2+3)-(4)
Figure obtained is the solution and is capable of explaining the business lacking. This figure is beneficial for the start-ups to rectify the mistakes. Quality and customers are a priority and maintain the cash conversion cycle. You can always seek legal aid.
