Question

Why is understanding the relationship between the cash conversion cycle (CCC) and net working capital important to the contemporary business executive? Explain ways in which executive decisions regarding the CCC and net working capital can affect a company, both adversely and beneficially. Support your response with a specific example from the business world.

Answer 1

Answer:

Given that:

Why is understanding the relationship between the cash conversion cycle (CCC) and net working capital important to the contemporary business executive? Explain ways in which executive decisions regarding CCC and net working capital can affect a company, both adverse and beneficial. Support your response with a specific example from the business world.

Working Capital equals corporate short-term assets minus short-term liabilities. Working capital is a liquidity indicator that provides a glimpse into how much cash a business will have in its coffers for the next 12 months.
Working capital = Current assets - Current liabilities

Cash Conversion Cycle (CCC) to days required to convert company's input cost into cash realization. while working capital tell us about amount blocked for net current assets to support the business operations.
CCC = DSO + DIO — DPO

CCC is relative terms which enables financial users to compare the performance in working capital management with other peers in the market.
On the other hand, working capital is an absolute value and doesn't enable the comparison of this measure with other peers of different size and pattern.

Giving higher credit to customers or holding higher inventory or lowering credit from suppliers will increase length of CCC and will prove counterproductive.

Similarly, these actions will also increase working capital and hence higher funding cost.

Company under retail management are able to achieve negative CCC, which can be best proposition. Amazon is example for that. It operated with inventory holding of 30 days, DSO of 10 days and DPO of 55 days.

CCC = 30 + 10 - 55 =

=-15 days.

Negative CCC doesn't always mean working capital will also be negative because receivable is recorded as sales value while inventory and payables are recorded at cost.

So, sometimes companies with higher profit margins might have negative CCC but working capital still be positive.