![]() Third, the calculations vary slightly between days receivable and days inventory and days payable. Days receivable is calculated based on sales, i.e.,, but the other two measures use cost of goods sold (COGS) because the cost of inventory purchased from suppliers is the primary component of COGS. Second, the days measure is really just the inverse of the turnover ratio. For example, if a borrower’s inventory turns over 6 times a year, that means the borrower carries a 61-day supply of inventory (365 days/6 times = 61 days), or said another way, the borrower is stuck with the inventory and all its related carrying costs, e.g., security, storage, utilities, etc., for the 61-day period. Naturally, the faster the turnover, the fewer the number of days on hand and the lower the carrying costs. So, the faster that the borrower’s cash can pay suppliers for inventory, the faster the inventory can be sold to customers, and the faster that the cash proceeds can be collected from client receivables, the more bankable the borrower. On the other hand, paying suppliers slowly tends to diminish supplier credit, slow-turning inventory runs the risk of style or technological obsolescence or just plain physical deterioration, and past-due receivables threaten possible charge-off. Reliance on liquidity measures like the current ratio ignore the time risk a current ratio of 2.0x might simply mean that the borrower’s stale inventory and past-due receivables are twice as much as its past-due trade credit and non-accrual bank loan. After writing down unsaleable inventory and charging off bad receivables, the borrower is unlikely to be able to pay either its suppliers or its banker. So how do we identify, monitor, and manage the cycle risk?įirst, let’s define CCC as the sum of days receivable plus days inventory minus accounts payable. A positive CCC indicates the number of days a borrower must borrow or rely on its own capital while waiting for its customers to pay their invoices. A negative CCC tells us the number of days of customer cash the borrower has accumulated before it has to pay its suppliers. Therefore, a strong borrower has a low positive CCC or a negative CCC. Comes Around captures this spirit, “What goes around, goes around, goes around, Comes all the way back around.” So, let’s examine the CCC to see how it works its way around.Ĭurrent assets might not make the world go round, but they keep most businesses running only as long as they stay current. American poet Ralph Waldo Emerson observed, “No man can help another without helping himself.” Sometimes bankers can help borrowers when they help themselves, and the cash conversion cycle (CCC) is a great self-help example. Sure, lenders need to get a sense of how long it takes a borrower to cycle cash through its business, but the metrics employed to measure that time can also help the borrower manage its own working capital. Justin Timberlake’s 2006 What Goes Around.
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