Cash Conversion Cycle As A Company Liquidity Measure

Effective and adequate management of a company’s liquidity position represents a key element in securing the overall ability of a company to meet its short-term obligations using assets that are readily converted into cash. The company’s liquidity position is especially important in today’s globalized and highly competitive business environment, as well as in times of economic and financial hardships characterized by decreasing cash inflows and deteriorating market conditions. In order to predict, manage, and evaluate the liquidity position, the company utilizes specific analytical tools and measures. Apart from usual static measures of liquidity such as liquidity ratios (e.g. current and quick liquidity ratios), the cash conversion cycle (or cash gap cycle) represents dynamic measure, which incorporates the element of time in the consideration. The cash conversion cycle is defined as a number of days between actual cash outflows on a company’s purchase of needed productive resources and actual cash inflows resulting from product sales. It measures the time between outlay of cash and cash recovery from a company’s regular course of operation. During that period of time, the financial funds are tied up in the current assets, such as payables, inventories, and receivables. The shorter cash conversion cycle, stated in a number of days, indicates better liquidity and working capital position of a company. Quick cash recovery is a permanent business consideration, especially in the short term and in smaller firms. A successful management of the cash conversion cycle implies the effective management of individual components of current assets. The company management undertakes a different set of activities to decrease inventory and receivables conversion periods, as well as to increase payables deferral period in order to shorten the cash cycle and quickly release the funds that are invested in a working capital. The concept of cash gap is closely related to the net working capital management and it is regarded as a method for cash flow management. Therefore, the aim of this paper is to present an overview of the cash conversion cycle concept and its importance in relation to the measurement of the liquidity position of a company. The relations between the cash gap and net working capital management will be explained, as well as basic financial management implications of the concept for the company’s business operations. Additionally, the concept will be illustrated with a sample of companies that makes the index CROBEX10 of the Zagreb Stock Exchange.