Topic 9 Cash conversion cycle

Introduction

This is sometimes referred to as the ‘cash-to-cash’ conversion cycle, which is probably a

more descriptive term. The underlying principle is that a company incurs costs (ie pays out
cash) in order to source materials and fund production and then receives cash from the sale
of the finished goods once production has been completed and goods have been sold.

Learning objectives

By the end of this topic, you will understand:

• what is meant by the term ‘cash conversion cycle’;

• how the timing (not just the value) of payments in and out has a material impact on
the cash conversion cycle;
• how payment terms agreed with suppliers impact DPO;
• how production and stockholding times impact DIO;
• how payment terms agreed with buyers impact DSO;
• how supply chain finance products and techniques can be used to address funding
gaps arising as a consequence of DPO, DIO and DSO; and
• how supply chain finance can be used to modify DPO, DIO and DSO.

Think...

Have you ever wondered why a company might choose to use supply chain finance rather
than other financing solutions?

Why is ‘balance sheet treatment’ important for some companies but irrelevant for others?
Is it possible for a company to fund their inventory and receivables by simply taking longer
to pay their suppliers? If so, why don’t they do that?

Similarly, is it possible for a company to demand payment in advance from buyers in order
to fund payables and inventory? Why don’t they do that?

9.1 Key considerations

In order to understand a company’s cash conversion cycle, the following factors need to be
analysed:

• the cash value paid out;

• the timing of outbound cash payments;

© The London Institute of Banking & Finance 1

 • the timing of inbound cash receipts; and
• the cash value of receipts.

Timing of payments

If a company is trading profitably, the cash receipts should exceed the cash paid out, but the
timing of these payments is crucially important as this determines the solvency of the
company. The key factors that will determine the timing of payments and receipts are:

• the payment terms agreed with suppliers;

• the production and stockholding periods; and
• the payment terms agreed with buyers.

Payment terms and production/stockholding periods are directly impacted by the nature of
the goods and the relative negotiating power of the buyer and the seller. In addition, the
countries where the buyer and seller are domiciled and the transit times can also have a
major impact.

9.2 Payment terms agreed with suppliers

As mentioned in the last section, payment terms can vary greatly.

The most advantageous terms for the seller, 100% payment in advance, are also the least
advantageous for the buyer (our client, in this example). Aside from the risks to which our
client (the buyer) is exposed, the main concern in this case will be that the client will have to
pay out cash before the goods that they are sourcing have even been shipped. Given that
the client will have to convert the goods sourced into finished products and then sell them
to their buyers, this suggests that they will be ‘out of funds’ in respect of this particular
trade cycle for several months.

At the other extreme, the most advantageous terms for the buyer (our client), 100%
payment after a deferred credit period, are also the least advantageous for their supplier.
By having to pay out cash later in the trade cycle, our client will reduce or even eliminate
the period during which they are ‘out of funds’ whilst they complete the production and
sales processes.

Between these two extremes, we will see terms that specify that payment is made
immediately upon shipment or perhaps immediately upon receipt of goods by our client.

Sometimes, trading parties will agree terms of payment that combine multiple payment
arrangements. For example, it is not uncommon to see the following combination:

• 20% payment ‘with order’ (ie upon signing of the purchase order, prior to shipment);
• 50% upon shipment;
• 30% 60 days after shipment.

© The London Institute of Banking & Finance 2

As noted earlier, the important variables are the value of cash paid out and the timing of
payments.

9.2.1 Days payable outstanding (DPO)

The metric used to measure payment terms agreed with suppliers is known as ‘days payable
outstanding’ (DPO). This metric is typically used to measure a company’s average payment
terms, but can also be applied to individual suppliers or lines of business. The formula for
calculating DPO is set out below.

Formula

D = P/E * 365

Abbreviations

• P = the value of approved payables outstanding;

• E = the annual expenditure on materials sourced from suppliers;
• 365* = the number of days in the year; and
• D = the value of payables expressed as the average number of days’ credit taken from
suppliers.

* We have used 365 days in this example, but in many markets (eg USA) the convention is to
use 360 days.

Example

To illustrate the application of this formula using numbers, let us assume our client’s
balance sheet and P&L reveal the following numbers:

• P = £500,000 (this is the value of approved payables in the balance sheet)

• E = £3,000,000 (this is the expenditure on materials sourced from suppliers)

500,000/3,000,000 * 365 = 60.83

So, the average DPO for this client is 60.83 days.

Is this ‘good’ or ‘bad’?

This depends on what is typical among the peer group in the industry. A shorter than
average DPO might suggest that a company is inefficient in the management of its
procurement process and is agreeing terms with suppliers that are far too generous. On the

© The London Institute of Banking & Finance 3

other hand, it might mean that a company has surplus liquidity and is prioritising profit over
cash flow.

Similarly, if DPO is longer than average, this might suggest that the company’s highly
efficient procurement function is negotiating particularly favourable terms with suppliers.
On the other hand, it may mean that they are running out of cash and are delaying payment
to suppliers, jeopardising their reputation, damaging supply chain stability and approaching
insolvency. It might also mean that they are abusing their strong bargaining position to force
onerous terms onto their suppliers, leading to accusations of bullying and undermining the
financial health of key suppliers.

Peer group comparison and trend analysis are essential, along with asking the client about
their payment terms and strategy.

You will notice that we have not mentioned the settlement method here. For the purposes
of trade cycle analysis, we need to understand the cash flows on the basis that there is no
financing in place and no bank intermediation involved.

9.3 Production and stockholding periods

The duration of production and stockholding periods will vary greatly depending on the
nature of the materials being sourced, the activities involved in the production of finished
goods, and the nature of the goods themselves. Industry practices will also impact the
duration.

9.3.1 Wholesale importer scenario

If our client is a wholesale importer and distributor of goods to retailers, the goods being
sourced are most likely to be exactly the same as the goods sold. Apart from any
repackaging or labelling that may be required, there is minimal production activity. It is
usually just a case of breaking up larger consignments received from suppliers into smaller
consignments for sale to retailers.

In this case, inventory would comprise only finished goods, with no raw materials or WIP.
The stockholding period ought, therefore, to be quite short. In practice, however, the
negotiating power of our client relative to the retailer buying their goods can also have a
material impact. Many retailers, for example, insist on their suppliers maintaining sufficient
stock to make deliveries at very short notice. This allows the retailer to adopt a ‘just-in-time’
approach to stockholding, reducing the cash they have tied up in stock.

The corollary of this is, of course, that the supplier (our client, in this example) has to hold
much higher levels of stock pending call off by the retailer. Our client has, therefore, to

© The London Institute of Banking & Finance 4

support higher levels of stock than would otherwise be the case. This ties up cash and
extends the gap between ‘cash out’ and ‘cash in’ in the cash conversion cycle.

9.3.2 Manufacturing scenario

In a manufacturing scenario, the stock would be split into raw materials, work in progress
(WIP) and finished goods. It is likely that the duration of the production and stockholding
periods will be longer than would be the case for a wholesale distributor. The relative
bargaining power of the supplier (our client) relative to their buyer can still have a material
impact. The client is just as likely to be subject to ‘just-in-time’ delivery standards, which
would necessitate holding higher levels of each of the three categories of inventory as a
result.

The level of stockholding is also impacted by the client’s relationship with the suppliers from
whom they source materials. Better pricing might be achieved for larger consignment sizes,
so the client might have to make a difficult decision between prioritising profit relative to
cash flow. Profitability would be enhanced by lower unit pricing, but the consequential
impact on stockholding would be to increase the duration of the production and
stockholding periods, extending the gap between ‘cash out’ and ‘cash in’.

9.3.3 Logistics

Logistics can also have an impact. If our client in Europe or North America is sourcing from
South East Asia, the cost of freight will be a factor. Smaller, more frequent shipments are
likely to be more expensive than fewer, higher-value shipments.

Generic goods

Another practical consideration that will have an impact on consignment size is the nature
of the materials being sourced. If they are generic (eg standard AA batteries), the supplier
will have a continuous production line in operation, manufacturing vast quantities of
identical products. It makes no difference, in terms of cost of production and operational
efficiency, whether the manufacturer receives a large order or a small order.

Specific or unique products

If, on the other hand, the product is designed specifically for a particular buyer (eg branded
garments), the manufacturer would have to set up the production process with the
appropriate designs, patterns and settings before production can begin. It would be far less
efficient to set up for 12 very short runs, lasting perhaps one week each to facilitate
monthly shipments, than to set up just once for a production run lasting 12 weeks to
facilitate a single shipment covering the full year’s product requirement.

© The London Institute of Banking & Finance 5

9.3.4 Days inventory outstanding (DIO)

The metric used to measure production and stockholding periods is known as ‘days
inventory outstanding’ (DIO). This metric is typically used to measure a company’s average
rate of stock turnover, but can also be applied to individual lines of business. The formula
for calculating DIO is similar to that for DPO.

Formula

D = I/T * 365

Abbreviations

• I = the value of inventory (raw materials + WIP + finished goods);

• T = the annual turnover/sales;
• 365 = the number of days in the year; and
• D = the value of inventory expressed as the average number of days taken to convert
inventory into receivables.

Example

To illustrate the application of this formula using numbers, let us assume our client’s
balance sheet and P&L reveal the following numbers:

• I = £250,000 (this is the value of inventory in the balance sheet)

• T = £3,500,000 (this is the turnover/sales)
• 250,000/3,500,000 * 365 = 26.07

So, the average DIO for this client is 26.07 days.

You will note that we have used the sales turnover figure rather than the ‘cost of goods
sold’ figure (known as COGS). One can make an argument for the use of COGS in preference
to sales turnover, but in practice the latter is generally preferred for a number of reasons:

• COGS may not be readily determinable in the P&L, whereas sales turnover is;
• COGS may include costs that are not directly related to the value of inventory,
distorting the ratio; and
• as the finished goods have a selling price that eventually translates into cash in, it is
probably more logical to reference sales turnover to all categories of inventory,
rather than try to use COGS for raw materials and apportion production costs to WIP
and then use the selling price for finished goods.

© The London Institute of Banking & Finance 6

In practice, it is more important to be consistent and make all comparisons on a like-for-like
basis than to attempt to be ‘accurate’ in absolute terms.

As with DPO, one cannot say whether this number is ‘good’ or ‘bad’ in isolation. If the
industry norm is 60 days, then that might suggest that the client is operating at a very high
level of efficiency. On the other hand, it might indicate that the client is destocking and will
eventually be unable to take further orders for their products. Trends and peer
group/industry comparisons are critically important. It is also vital, as part of the discussion
with the client regarding the supply chain finance needs, to ask them what is driving their
working capital ratio changes.

9.4 Payment terms agreed with buyers

The considerations that have an impact on payment terms with buyers are exactly the same
as we saw with suppliers. In this case, however, our client is the seller, not the buyer.

As stated in 9.2, the most advantageous terms for the seller (now our client, in this
example), 100% payment in advance, are also the least advantageous for the buyer. By
receiving cash earlier in the trade cycle, our client will reduce or even eliminate the period
during which they are ‘out of funds’ whilst also eliminating the risk of order cancellation or
non-payment.

At the other extreme, the most advantageous terms for the buyer, 100% payment after a
deferred payment period, are also the least advantageous for our client (the supplier).

Between these two extremes, we will see terms that specify that payment is made
immediately upon shipment by our client or perhaps immediately upon receipt of goods by
the buyer.

Sometimes, trading parties will agree terms of payment that combine multiple payment
arrangements. For example, it is not uncommon to see the following combination:

• 20% payment ‘with order’ (ie upon signing of the purchase order, prior to shipment);
• 50% upon shipment; and
• 30% 60 days after shipment.

As noted earlier, the important variables are the value and timing of cash received.

9.4.1 Days sales outstanding (DSO)

The metric used to measure payment terms agreed with buyers is known as ‘days sales
outstanding’ (DSO). This metric is typically used to measure a company’s average sales
terms but can also be applied to individual buyers or lines of business. The formula for
calculating DSO is similar to those for DPO and DIO.

© The London Institute of Banking & Finance 7

Formula

D = R/T * 365

Abbreviations

• R = the value of receivables outstanding;

• T = the annual sales turnover;
• 365 = the number of days in the year; and
• D = the value of receivables expressed as the average number of days’ credit given to
buyers.

Example

To illustrate the application of this formula using numbers, let us assume our client’s
balance sheet and P&L reveal the following numbers:

• R = £500,000 (this is the value of receivables in the balance sheet)

• T = £3,500,000 (this is the turnover/sales)
• 500,000/3,500,000 * 365 = 52.14

So, the average DSO for this client is 52.14 days.

Once again, we have not mentioned the settlement method here. For the purposes of trade
cycle analysis, we need to understand the cash flows on the basis that there is no financing
in place and no bank intermediation involved.

9.5 Importance of DPO, DIO and DSO

Supply chain finance, as we have discussed, is ‘the use of financing and risk mitigation
practices and techniques to optimise the working capital and liquidity invested in the supply
chain processes and transactions’ (GSCFF, 2016, p24). It therefore has a strong relationship
with DPO, DIO and DSO, the key working capital metrics; for example:

• it can finance payables, inventory and receivables (sales) which determine DPO, DIO
and DSO respectively; and/or
• it can impact the actual DPO, DIO and DSO ratios.

© The London Institute of Banking & Finance 8

Financing payables, inventory and receivables

Taking a helicopter view initially, the sum of DPO, DIO and DSO represents the overall cash
conversion cycle. Note that if DPO is positive (ie the company is taking credit from their
suppliers), then we need to deduct that from the DIO and DSO numbers. This is because DIO
and DSO relate to the time taken to receive cash, whereas DPO relates to the time taken to
pay away cash. As we are expressing the cash conversion cycle in terms of the number of
days during which the company is ‘out of funds’, DIO and DSO makes the number bigger,
whereas DPO makes the number smaller.

In the examples used in 9.2, 9.3 and 9.4, we have:

• DPO: 61 days
• DIO: 26 days
• DSO: 52 days

The cash conversion cycle is, therefore, 26+52–61= 17 days.

In this example, DPO is relatively long, while DIO and DSO are quite short. As a result, the
resulting cash conversion cycle is just 17 days. In other words, the company’s suppliers are
effectively financing a good proportion of the time taken to convert inventory and
receivables into cash.

Impact of changing payment terms

Imagine if the company’s suppliers suddenly demanded payment immediately upon

shipment; DPO would reduce to zero and the cash conversion cycle would increase to 78
days. Imagine if, on top of the change in DPO, the company’s customers demanded 30 days
additional deferred payment terms; the cash conversion cycle would increase to 108 days.

This is a somewhat simplistic model that serves purely to illustrate how the three working
capital metrics relate to funding and liquidity. In order to calculate funding requirements
accurately, we must dig deeper. We must also take into account peaks and troughs – we
cannot just work on the basis of annual averages as trade may well be seasonal. In the
clothing industry, for example, a company will build up stock ahead of the peak selling
season. Think about heavy winter coats; a company is likely to start building up stock prior
to the start of the winter period when demand is likely to be at its greatest. Sales of such
garments are likely to dwindle as the weather improves, so the company will want to
replace winter stock with lighter garments better suited to warmer weather.

9.6 How do companies raise finance?

A company can raise finance in a number of ways. Supply chain finance is just one option,
though it can be argued that this is the most appropriate option as the provision of finance
is related to the underlying trade cycle that drives the cash conversion cycle. The critical
characteristic of supply chain finance is that the source of repayment of advances derives
directly from the cash conversion cycle.

© The London Institute of Banking & Finance 9

Multinational corporations (MNCs)

The finance options available to a company will depend on its size and credit standing. An
investment grade multinational corporate has many options when it comes to raising
finance, including syndicated revolving credit facilities and capital markets instruments.
Such a company is unlikely to choose supply chain finance purely because they have a
financing requirement, though they might choose supply chain finance for other reasons (as
we shall see later).

SMEs: Benefits of supply chain finance compared with overdrafts

At the other extreme, an SME has very limited finance options. In many cases, there is an
overreliance on overdraft or loan, provided by their sole bank relationship. The bank will
have taken security over the SME’s assets in accordance with the conventions applicable in
the country where they are domiciled. An overdraft is attractive to an SME due to its
inherent flexibility, but it is precisely this flexibility that results in the bank’s appetite being
somewhat constrained. The bank has no visibility or control of the utilisation of the
overdraft facility and the overdraft limit is not related to the finance requirements driven by
the cash conversion cycle. The overdraft limit tends to be determined by reference to the
security valuation, which itself is conservative and backwards-looking. An overdraft limit
cannot easily support the finance needs of a growing business with a growing order book.
Supply chain finance, by contrast, being linked to the trade cycle and hence the cash
conversion cycle, typically provides a measure of visibility, control and a security interest in
the source of repayment.

Visibility, control and security

The greater visibility, control and security should, all other things being equal, lead to
increased availability of, and easier access to finance. As new, non-bank finance providers
have entered the market in recent years, companies of all sizes now have greater choice and
are no longer dependent on the sole or core bank relationship(s). Factoring/invoice discount
companies (some independent and some bank-owned) have been around for many years.
They have now been joined by innumerable fintechs that are able to leverage advanced
technology to facilitate the provision of finance. In some cases, these fintechs do not
provide the finance themselves but operate as intermediaries, connecting those with
funding needs to investors via a platform.

DPO, DIO and DSO metrics have a clear relationship with the level of working capital funding
required by a company. This will be covered in greater detail in Topic 10, when we cover the
trade cycle analysis process. For now, it is useful to understand how changes in any of these
metrics impact funding and liquidity.

© The London Institute of Banking & Finance 10

9.7 Accounting treatment and MNCs
In the previous section, we discussed the use of supply chain finance techniques to finance
funding gaps arising from a company’s working capital metrics. In this section, we consider
how certain supply chain finance techniques can actually change the metrics.

You will learn about the impact of specific techniques in later topics, when we look at
individual products and techniques in detail. For now, we will identify the principal ways in
which supply chain finance can impact the working capital metrics.

Role of external auditors

What we are talking about here is known as ‘accounting treatment’. As such, it is dangerous
to be too dogmatic about the effect of certain solutions on a company’s balance sheet as
the ultimate authority on accounting treatment is the company’s firm of external auditors.
We can say with some confidence, however, that solutions that exhibit certain
characteristics are likely to result in the expected accounting treatment.

Understanding motivations

Accounting treatment will be more relevant to some companies than to others. We need to
understand the company’s ‘drivers’ when thinking about the optimum supply chain finance
structure.

Why do MNCs use supply chain finance?

In the previous section we noted that, whereas SMEs had few options with regard to raising
working capital finance, major multinational corporates (MNCs) are able to raise finance in
many ways, from multiple sources. Nevertheless, MNCs have been among the greatest
users of supply chain finance, particularly as techniques have developed in recent years.
Indeed, it could be argued that the relatively recent expansion in payables finance has been
driven almost entirely by MNC demand.

9.7.1 DPO impact

The reason for this is that payables finance can, if structured appropriately, attract
‘favourable’ accounting treatment. What do we mean by ‘favourable’ in this context?
Usually, there are two aspects:

• The financing is not treated as ‘bank debt’ in their balance sheet. In other words, the
‘trade creditors’ appearing on their balance sheet are not reclassified as bank debt.
• Their DPO is not reduced even though their suppliers are getting paid early.

Taking the reclassification issue first; MNCs are investment grade entities which are subject
to intense investor and analyst scrutiny. A reduction in trade creditors and an increase in

© The London Institute of Banking & Finance 11

bank debt would often be unwelcome indicators which investors and analysts would regard
as negative. There may also be lending covenants in place with the MNC’s panel of banks
(participants in their syndicated revolving credit facility, perhaps) which an increase in bank
debt might breach.

The DPO issue is closely related to the first. In this case, a DPO which is seen to be low
relative to an MNC’s peer group, might also be regarded as a negative indicator. Many
treasurers will want to demonstrate the efficiency of their working capital management by
ensuring that their key metrics are comparable or better than those of the peer group.

9.7.2 DSO impact

The same principles apply to DSO. An MNC might feel it needs to grant extended credit to its
customers in order to maintain competitiveness. Indeed, the MNC’s finance costs may be
lower than those of its customers, so the inclusion of a finance element might make a deal
more attractive to both parties. A receivables-purchase solution, appropriately structured,
can also receive ‘favourable’ accounting treatment. In this case, the key elements are:

• The financing is not treated as ‘bank debt’ in the balance sheet.

• The DSO is reduced as debtors are turned into cash in the balance sheet.

To illustrate how this ‘favourable’ treatment compares with a conventional loan, let us
consider the two types of financing solution side-by-side. For the purposes of this example,
let us assume the following payment terms have been agreed:

• MNC sells to customer on 90 days terms;

• invoice value is £10m;
• finance is raised on day 10 (after invoices are raised);
• the customer pays on day 90.

On day zero, when the invoice is raised, the following accounting entries would appear in
the MNC’s balance sheet in both scenarios (ie there is no difference at this stage between
the supply chain finance solution and the conventional loan):

• Inventory is reduced by £10m (assuming, for the sake of simplicity, that it was in the
balance sheet at its full invoice value); and
• Debtors are increased by £10m.

On day 10, when the finance is raised, we see the difference in treatment. First, using a
conventional loan:

• Bank debt is increased by £10m;

• Cash is increased by £10; and
• Trade debtors are still outstanding at £10m.

© The London Institute of Banking & Finance 12

Now, with supply chain finance:

• Trade debtors are reduced by £10m; and

• Cash is increased by £10m.

We have deliberately simplified the transaction and the bookkeeping in order to illustrate
the main point regarding accounting treatment. In practice, the deal structure would be
more complex..

9.7.3 DIO impact

This is a little more complicated than the DSO and DPO impacts, but the principles remain
the same.

Inventory cannot ‘disappear’. It must be on someone’s balance sheet. In most cases,

inventory will be on the seller’s balance sheet until it is transferred to the buyer’s balance
sheet. If a seller wants to reduce DIO, it will try to accelerate the ‘point of sale’ so that the
inventory sits on the buyer’s balance sheet. This will, of course, increase the buyer’s DIO. If a
buyer wants to reduce its DIO, it will try to force the seller to hold stock ‘pending call off’.
The buyer, in this case, will only accept the stock when they need it (just in time). This will,
of course, cause the seller’s DIO to increase.

So, how is it possible to reduce the DIO of both seller and buyer, keeping the inventory off
both balance sheets? This is possible with certain supply chain finance techniques. The
technique involves the finance provider becoming the true owner of the inventory, pending
call off by the buyer. The legal arrangements for this type of structure are quite complex,
involving extensive documentation. In practice, the finance provider buys the inventory on a
‘true sale’ basis from the seller. When the buyer is ready to acquire the goods, the structure
will generally mean that the finance provider resells the goods back to the seller while the
seller simultaneously sells the goods to the buyer.

In practice, the arrangements are rather more complex than is suggested by this simplistic
example. The aim here is to illustrate the principle.

9.7.4 Does this apply only to MNCs?

In practice, the accounting-treatment-led approach tends to be of primary interest to MNCs.

Mid-market companies and SMEs, however, might also seek to achieve favourable
accounting treatment, especially if they have lending covenants that would otherwise be
breached. It should also be noted that the techniques used to achieve favourable
accounting treatment might be attractive to a mid-market company or SME for other
reasons. A receivables-purchase arrangement that is structured as a ‘true sale’ might also
provide effective risk mitigation. In essence, the seller is protected against the risk that the

© The London Institute of Banking & Finance 13

buyer cannot pay once the receivable has been sold on a non-recourse basis to a finance
provider.

Conclusion
Trade cycle analysis enables us to understand the financial implications of a company’s
sourcing, production, selling and distribution operating model. Specifically, it illustrates the
impact of a company’s operating model on its working capital.

Supply chain finance products are designed to address the working capital needs of a
company by matching the provision of finance to the underlying trade cycle.

Certain supply chain finance techniques may actually have a direct impact on the three
metrics themselves.

Think again...

Now that you have completed this topic, how has your knowledge and understanding
improved?

For instance, can you:

• explain the connection between a company’s trade cycle and the resulting cash
conversion cycle;
• discuss how a company’s cash conversion cycle and those of their suppliers and buyers
are connected; and
• illustrate why supply chain finance is often the preferred solution, even though other
sources of finance might be available?

Test your knowledge

1. What is the cash conversion cycle?

Select one:

A. The process of translating a balance-sheet asset or liability denominated in a

foreign currency into the currency in which the accounts are struck.

B. The process of spending cash to generate sales that produce cash.

C. The process of converting debtors into cash.

© The London Institute of Banking & Finance 14
Feedback

The process of translating a balance-sheet asset or liability denominated in a foreign

currency into the currency in which the accounts are struck is a foreign exchange risk issue.
The process of converting debtors into cash is just one step in the cash conversion cycle.
(See Introduction.)

The correct answer is: The process of spending cash to generate sales that produce cash.

2. Which of the following are factors that determine the cash conversion cycle? Select all
that apply.

Select from:

A. The value and timing of cash paid out.

B. The value and timing of cash received.

C. The average stockholding period.

Feedback

The cash conversion cycle is determined by the value and timing of cash paid out and
received, as well as the average stockholding period. (See section 9.1.)

The correct answers are: The value and timing of cash paid out, the value and timing of cash
received, and the average stockholding period.

3. If P = $100,000, E = $2.5m and we are using a 365-day-year which of the following DPO
calculations is correct?

Select one:

A. 25 days

B. 14.6 days

C. 4.5 days

Feedback

The formula is:

D (number of days) = P/E *365; where:

© The London Institute of Banking & Finance 15

P = the value of approved payables outstanding; and

E = the annual expenditure on materials from suppliers. (See section 9.2.1.)

The correct answer is: 14.6 days.

4. If I = $500,000, T = $10m and we are using a 365-day-year, which of the following DIO
calculations is correct?

Select one:

A. 18.25

B. 20

C. 15.5

Feedback

The formula is:

D (number of days) = I/T *365; where:

I = the value of inventory; and

T = the annual turnover/sales.

(See section 9.3.4.)

The correct answer is: 18.25.

5. If R = $2.5m, T = $10m and we are using a 365-day-year, which of the following DSO
calculations is correct?

Select one:

A. 91.25

B. 40

C. 66.6

© The London Institute of Banking & Finance 16

Feedback

The formula is:

D (number of days) = R/T *365; where:

R = the value of receivables outstanding; and

T = the annual turnover/sales.

(See section 9.4.1.)

The correct answer is: 91.25.

6. Which of the following statements is/are correct?

Select one:

A. If a company takes longer to pay suppliers, the overall cash conversion cycles will
get longer.

B. If a company increases credit terms to customers, the overall cash conversion

cycle will get longer.

C. If a company holds higher levels of stock, the overall cash conversion cycle will get
shorter.

Feedback

If a company takes longer to pay suppliers, the overall cash conversion cycle will get shorter.
This is because the cash conversion cycle measures the time a company is ‘out of funds’ so,
if they pay later, they are ‘out of funds’ for a shorter period. If a company holds more stock
relative to sales, the overall cash conversion cycle will be longer as they will be ‘out of funds’
for a longer period. (See section 9.5.)

The correct answer is: If a company increases credit terms to customers, the overall cash
conversion cycle will get longer.

References
GSCFF (2016) Standard definitions for techniques of supply chain finance [pdf]. Available at:
http://supplychainfinanceforum.org/ICC-Standard-Definitions-for-Techniques-of-Supply-

© The London Institute of Banking & Finance 17

Chain-Finance-Global-SCF-Forum-2016.pdf
https://cdn.iccwbo.org/content/uploads/sites/3/2017/01/ICC-Standard-Definitions-for-
Techniques-of-Supply-Chain-Finance-Global-SCF-Forum-2016.pdf [Accessed: 4 May 15
March 202218].

© The London Institute of Banking & Finance 18