# Cash Conversion Cycle

Ok, so one question on a mock is twisting up my thoughts.

We know that CCC = Average days of receivables + average days of inventory - average days of payable.

You want this to be a low number. So you want average days of receivables and days of inventory to be low. You also want the average days of payables to be high.

So the questions shows 2 companies with weighted average collection period, inventory turnover, and payables turnover.

The weighted average collection period is in days, and the turnovers are in times: 7 times, 10 times, 9 times.

Weighted average collection period, you want to have less days, which also means you have stricter credit policy.

Inventory turnover = 7 times vs 10 times. I believe you want this number to be high? 10 times is better than 7 times. Can someone please explain why?

Payables turnover = 9 times vs 12 times. This is what kind of tricks me up. You want this to be lower. 9 times is better than 12 times, and it means you can take a longer time to pay suppliers. I first thought it would be 12 times, because of the CCC.

Thanks!

A high Inventory turnover is generally better (although still want it to be similar to the industry average) as it is essentially saying a sell through all my stock 10 times a year. The more you can times you can sell through your stock, the better. Right?

Regarding payables turnover, think back to the CCC equation which says the time it takes to turn resources into cash. The equation for average days payable, as you know is 365/ payables turnover. Therefore put both 9 and 12 into this equation. 9 days gives 40, which when we plus 40 into the CCC equation, it results in a lower number, i.e, it reduces the time to convert stock into cash.

The CCC is calculated using using avg days inventory, receivables, etc. So in order to get avg days, you must divide 365 by the turnover.

So yes, you want inventory turnover to be high but AVG DAYS in inventory to be low. And this is the number used for the CCC.

hope this helps!

Makes sense. kind of made sense after i started typing out the question. hopefully, i dont get these brain farts on the actual exam…

THANKS!

You want number of days of payables to be high . . . but not too high.

You want number of days of inventory on hand to be low . . . but not too low.

You want number of days of sales outstanding to be low . . . but not too low.

Hence, you want CCC to be short . . . but not too short.

Basically, the analysis will be more effective if you are looking at two companies or comparing the firm’s average to the industry average.

so, Comparing with the industry average, the following analysis will be good:

Number of days of payables (Average payment period) to be higher

Number of days of sales outstanding (Average collection period) to be lower

Number of days of inventory on hand to be lower…

Conversely, Analysing 2 Companies will be different

Hope this helps…