Working capital efficiency can be assessed working with money conversion cycle (CCC). Let us look at the computation of CCC along with its inference rule.
Hypothetical illustration
Let us assume the following figures (quantity in Rs crore) for Abhijit Dipankar Phanindra Ltd (ADP) for its newest economic year: Current assets 1,200 Trade receivables 600 inventories 400 money and money equivalent one hundred other present assets one hundred present liabilities 800 trade payables 300 accrued expenditures one hundred present portion of lengthy term debt 150 brief term bank loan 150 other present liabilities one hundred sales income 2000 price of goods sold 1,200 each day sales 5.48 (2000/365 days) each day price of goods sold 3.29 (1200/365 days).
Cash Conversion Cycle (CCC)
It is the excess of the operating cycle more than the days payables of a firm. Operating cycle is the sum of days receivables and days inventories. While operating cycle reflects the days taken by a firm in finding back its funds tied up in inventories and receivables, CCC reveals the days payables adjusted days in finding back the money that goes out in the operations of a firm.
Days Inventories (DSI)
It is the quantity of days a firm shops inventories and is computed by dividing inventories by the each day price of goods sold (CGS) of a firm. For ADP, it is 122 days (inventories of Rs 400 crore divided by each day CGS of Rs 3.29 crore) for the present year. Lower the days inventories, much better is the inventory management efficiency of a firm. If the DSI of ADP was 150 days in the earlier year, then the firm has enhanced its inventory management efficiency in the present year.
Days Receivables (DSO)
It is the quantity of days a firm requires in collecting its receivables. It is computed by dividing trade receivables by each day sales of a firm. For ADP, it is 109 days (trade receivables of Rs 600 crore divided by each day sales of Rs 5.48crore) for the present year. Lower the typical collection period, much better is the receivables management efficiency of a firm. If days receivables of ADP have been 120 days in the earlier year, then the firm has enhanced its receivables management efficiency in the present year.
Days Payables (DP)
It reveals the quantity of days taken by a firm in clearing its dues. It is calculated by dividing the trade payables and accrued expenditures by each day price of goods sold (CGS). For ADP, DP is 122 days. This indicates that ADP is taking 122 days to spend its suppliers. If the firm’s DP was 140 days in the earlier year, then it has grow to be inefficient in its payables management in the present year.
The inference rule is larger the DP, much better is the efficiency.
Cash Conversion Cycle (CCC)
The CCC for ADP is 109 days (DSI of 122 days plus DSO of 109 days minus DP of 122 days) in the present year. It was 130 days (DSI of 150 days plus DSO of 120 days minus DP of 140 days) in the earlier year. The firm has taken 109 days for getting back a rupee that has gone out from its operations in the newest year even though it had taken 130 days for the very same in the earlier year. Hence, the working capital efficiency of the firm has enhanced in the present year.
The writer is associate professor of Finance at XLRI — Xavier School of Management, Jamshedpur