Cash to cash cycle definition
/What is the Cash to Cash Cycle?
The cash to cash cycle is the time period between when a business pays cash to its suppliers for inventory and receives cash from its customers. The concept is used to determine the amount of cash needed to fund ongoing operations, and is a key factor in estimating financing requirements. You should have a firm understanding of the cash to cash cycle when constructing a budget, in order to properly estimate when additional funding will be needed.
The calculation is especially useful when there are indications that payment or receipt intervals are likely to change, so that one can estimate the impact on cash. It is also useful when attempting to recover a business from a bankruptcy situation, where cash is in short supply. A further use is when the cost of debt is high, and management is looking for alternatives that will require less outside funding. Yet another use is when investors want a dividend distribution, and management needs to extract cash from operations in order to make this payment.
How to Calculate the Cash to Cash Cycle
The cash to cash calculation involves adding together the days of inventory on hand and the days of sales outstanding, and then subtracting the number of days of payables outstanding. The formula is:
Days inventory on hand + Days sales outstanding - Days payables outstanding
= Cash to cash days
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Example of the Cash to Cash Cycle
The inventory held by a business averages being on hand for 40 days, and its customers usually pay within 50 days. Offsetting these figures is an average payables period of 30 days. This results in the following cash to cash duration:
40 Days of inventory + 50 Days sales outstanding - 30 Days payables outstanding
= 60 Cash to cash days
This outcome states that a business must support its expenditures for a period of 60 days.
How to Shorten the Cash to Cash Cycle
Examination of the components of cash to cash cycle calculation might lead management to take several actions to reduce the duration of the cycle, such as the following:
Shrink the amount of on-hand inventory
Tighten credit to customers
Require payment in advance
Negotiate longer payments terms with suppliers.
Terms Similar to the Cash to Cash Cycle
Cash to cash is also known as the cash conversion cycle.
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