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In business operations, the term Cash Conversion Cycle (CCC) refers to the average time that elapses when a business enterprise makes a payment for particular inventory investment and the time when the agency receives payment on the record from its customer (Jose, Lancaster, & Stevens, 1996). The purchase of the inventory is usually marked by the issuance of sales receipt (Jose, Lancaster, & Stevens, 1996). The length of the cash conversion cycle determines how fast or short, a business enterprise may obtain the necessary capital for additional purchases or settlement of debts (Moss, & Stine, 1993).
For instance, a wholesaler may, make an order for goods on February 4, 2013 with a payment date due on February 14, 2013. The wholesaler then sells the goods to the retailers on February 10, 2013 while the wholesaler receives payment on February 31, 2013. In this case, the cash conversion cycle amounts to a total of 17 days. The cash conversion cycle is often used by business firm operators to measure the time that may elapse when the business outflows cash to suppliers or manufactures and the time cash may be recovered through payments from customers (Jose, Lancaster, & Stevens, 1996). Cash conversion cycle may be shortened by a business enterprise through speeding up the payments received from customers while delaying payments made to the suppliers (Moss, & Stine, 1993).
However, the biggest challenge facing this trend in business operation is that while business firm’s suppliers offer pressure of more quick payment from the business (debtors), the customers such as the retailers or wholesalers often tends to delay the payments (Jose, Lancaster, & Stevens, 1996). Perfection and desirable success in business activities are achieved through a system where cash is received before it flows out (Moss, & Stine, 1993).
On the other hand, a business Operating cycle refers to the time that elapses when a business firm purchases an inventory, and the time when it receives payments for the particular inventory. The payment of the inventory by the customers is usually confirmed when receipts are issued (Jose, Lancaster, & Stevens, 1996). The average period of collection of the inventory and the overall age of particular inventories form the business operating cycle.
The length of a business operating cycle affects the profitability of most business operations. For instance, when the operating cycle extends into longer periods, the firm’s profitability tends towards minimum (Moss, & Stine, 1993). The decrease is due to increased expenses on interests as well as borrowing requirements.
Similarly, if a business firm experiences a shorter period of operation, the firm is likely to receive a more prompt profit on its inventory (Moss, & Stine, 1993). Furthermore, a business firm’s operating cycle tends to last for longer periods during economic stagnation, but lasts for shorter periods during rapid economic growth. Operating cycle is obtained by summing up the period of inventory conversion, and the period of receivables conversion (Moss, & Stine, 1993).
Large operating cycles often results into larger proportions of investments in not only the long term, but also in current assets. Generally, operating cycle is applied in the acquisition or raw materials, their conversion into final products for sale, and final collection of sales (Jose, Lancaster, & Stevens, 1996).
As a wrap up therefore, Cash conversion cycle would be an indispensable tool in ensuring success and profit maximization in business operations. This is because, through the application of cash conversion cycle, a business firm may determine the overall working capital of the firm at any period during business operations. Cash conversion cycle improves and facilitates proper decision making since it gives the business managers an idea of the total amount of money required to run the routine operations.
Jose, M., Lancaster, C., & Stevens, J. (1996). Corporate returns and cash conversion cycles. Journal of Economics and Finance, 20(1), 33-46.
Moss, J., & Stine, B. (1993). Cash conversion cycle and firm size: a study of retail firms. Managerial Finance, 19(8), 25-34.