Decoding cash conversion cycle

Mind your CCC for good health of your business.
Ensuring good health

Arnold Schwarzenegger's famous dialogue in the english movie, The Twins, "When money talks, bullshit walks" holds true for everything. A good cash flow is important to run any retail and this is possible if the cash conversion cycle is efficiently managed.CCC is ideally defined as the length of time between a firm's purchase of inventory and the receipt of cash from accounts receivable and is an expert analysis tool that determines where a company needs lending facility or where not and whether the company can meet financial obligations.

Large business firms tend to have shorter CCC periods than small retail businesses. The latter institutions can take steps however to reduce the extent of their cash conversion cycles, including reducing inventories or receivables conversions. CCC’s span is also inversely related to organizational cash flows, and a significant positive relationship exists between CCCs and current and quick ratios.

Cash conversion cycle is a measurement of business health, especially during growth. Therefore, it is important to effectively manage cash conversion cycle.

Cash conversion is forecasted on four factors:
    * The time (number of days) it takes customers to pay what they owe.
    * The time (number of days) it takes the business to make its products.
    * The time taken by the product to sit in inventory before it is sold.
    * The length of time that the small business has to pay its vendors.

For a correct picture of CCC, determine first Accounts receivable days, Inventory days and Accounts payable days by calculating as below:
    * Account receivable days: Receivable balance/last 12 months sale x 365 days.
    * Inventory days: Inventory balance/ last 12 months cost of goods sold x 365 days.
    * Company’s payable balance/ last 12 months cost of goods sold x 365 days.

Now, receivable days + production+ inventory days-payable days = CCC

 

Flitch rating firm reports, most retailers will continue with negative cash flows even in 2011. CCC of Indian retailers such as Pantaloons, Trent and Next retail remain high despite the drop in the cycle between 2007 and 2010.

While Pantaloon’s cycle of conversion has come down from 125 days in 2007 to 95 days in 2010, Videocon Group’s Next Retail saw a drop from 165 days to 130 days in 2010.

Trent, the retail arm of Tata witnessed a drop from 80 days to 70 days.

Shoppers stop achieved a drop from 30 days in 2007 to 10 days due to better inventory management.

In 2011, Fitch believes that the ongoing inventory management will reduce overall cash conversion cycles. It expects retailers to adopt measures such as increasing the proportion of bought-out sales (where inventory is held on vendor’s books while being physically on shop floor), increased use of franchise stores and streamlining supply chain operations.

“As companies expand, they will be able to negotiate better terms with creditors due to their larger scale, which will improve overall liquidity,” Fitch analysts Janhavi Prabhu and Tahera Kachwalla said.

In addition, over supply of retail space, 21 million sq ft between 2011-12, should allow retailers to negotiate lower deposits with developers, resulting in further improvement in liquidity, they said.

However, the agency expects most retailers, except Shoppers Stop, to continue with negative cashflows from operations in 2011 due to high working capital requirements.

“Shoppers Stop is likely to have positive cash flow from operations as well as positive cash flows due to better working capital management, and a slower pace of expansion,” the analysts said.

“However, in the longer term, as the pace of expansion moderates and working capital improvements materialize, more companies turn cash flow to positive,” they added.

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