Cash Conversion Cycle Theory: The Cash Conversion Cycle Of Business

888 Words 4 Pages
The study will be anchored on the following theories:

2.2.1 Cash Conversion Cycle Theory
Cash conversion theory was propounded by Blinder and Maccini (2001), cash conversion cycle theory is the time it takes a company to convert its resource inputs into cash. It evaluates how effectively a firm is managing its working capital. In most cases, a company acquires inventory on credit, which results in accounts payable. A firm can also sell products on credit, which results in accounts receivable. Cash, therefore, is not involved until the firm pays the accounts payable and collects accounts receivable. So the cash conversion cycle measures the time between outlay of cash and cash recovery (Siddiquee, Khan & Shaem Mahmud, 2009). This cycle is
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The lower the cash conversion cycle, the more healthy a company generally is. Businesses try to shorten the cash conversion cycle by speeding up payments from customers and slowing down payments to suppliers. Cash conversion cycle can even be negative; for instance, if the company has a strong market position and can control purchasing terms to suppliers that is it can postpone its payments (Brennan, 2003). Richards and Laughlin (1980) concluded that traditional ratios such as current ratio, Quick acid test and cash ratios cannot measure the true position about about working capital and insisted, using inflows and outflows of cash as a product of acquisition, production, sales, payment and collection process done over time. The firm’s ongoing liquidity is a function of its cash conversion cycle; hence the appropriateness of evaluation by cash conversion cycle, rather than liquidity measures (Wilner, …show more content…
Blinder and Maccini (2001) concluded that cash conversion cycle is the most important aspect in working capital management. In fact it tells about the investment and credit decisions in the customer, inventory and suppliers, which show average number of days started from the date when the firm starts payments to its suppliers and the date when it begins to receive payments from its regulars. Bodie & Merton (2000), analyzed the trends in the WCM and its influence on business performance for small manufacturers of Mauritius. He reported that firm’s needs for working capital of change over time depending on the rate of creation of money and high internal investment in inventories and receivables led to reduced profitability. There are two concepts of working capital namely quantitative and qualitative. According to quantitative concept, the amount of working capital refers to total of current assets. Current assets are considered to be gross working capital in this concept. The qualitative concept gives an idea regarding source of financing capital. According to qualitative concept the amount of working capital refers to “excess of current assets over current liabilities (Abuzayed, 2012). The excess of current assets over current liabilities is termed as Net working

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