The receivables collection period (DSO) for the
hotel is 30 days. Payable deferral period (DPO) is 60 days (htt). The cash conversion
cycle is given by the formula:
Cash conversion cycle is given by adding receivable
collection period to day inventory outstanding and then subtract payable
DSO represent day sales outstanding, DIO is day’s
inventory outstanding and DPO is the day’s payable outstanding.
The day’s inventory outstanding (DIO) is calculated
DIO= average inventories*365/cost of goods sold.
Average inventories (per annum) = (1088684+1052351)/2=1070518
Cost of sales=709556.
The cash conversion cycle =30+2-60=-28 days
in relation to cash conversion cycle
The cash conversion cycle for this firm is a process
where the inventories are purchased on credit and converted to sales made on
credit terms, and then collections in cash form are made in stipulated time.it
is a measure of how long the company’s cash is tied up in the inventory before
it is sold and payments from clients are collected.
conversion cycle for the hotel is a negative 28 days. The negative cash
conversion cycle implies that the hotel has an exceptionally good working
capital management system. When conducting the cash flow analysis of the firm,
the cash conversion cycle can be a very important metric that the top
management should put into consideration. A negative cash conversion cycle is
very desirable unlike the negative cash flows.
The management should continue setting a system that
ensures no payment for inventory is made until the final products associated
with the said inventory are paid. If this is achieved, efficiency use of
working capital is noted. Negative cash conversion cycles have a direct
positive impact with the cash flows (DAS, 2015). A lot of company’s
finances are not tied on working capital are therefore available to meet other
expenses and payments.
The inventory conversion period for the hotel is 2
days. This should be maintained since the majority of inventory items have
shorter expiry periods. The receivables collection period of 30 days should be
the maximum. The firm should establish strict debt collection department to
avoid the instances of bad debts. Payable deferral period of 60 days is
reasonable as compared to the 30 days the company collects from the
receivables. Any negotiations to increase the payable deferral period should be
encouraged in cases when the company is experiencing the cash flow related
problems (nobanee, 2009).
The management is in a position to manipulate the
cash conversion cycle to the benefit of the company. The finance department
needs to ensure that cash conversion cycle is shortened so that the financial
resources allocated to them are not tied up in the production process for more
than required periods. The production department manager should ensure a fast
production process while maintaining low costs. Sales and marketing department
too should ensure continuous, fast flow of clients in the hotel. Payment to
creditors should be delayed as much as possible without necessarily incurring
the late payment charges and penalties. The effects of the said measures are
that more working capital is freed and the firm, clients and suppliers
relationship is properly maintained.
Information related to
receivable collection period, payable deferral period, inventory and cost of
sales was extracted from http://leysin.redhotelsim.com/779c9.
The table below
contains workings related to cash conversion cycle;
(opening + closing)/2
inventories/cost of sales
DAS, S. (2015).
impact of cash conversion cycle on cash holdings. accounting, 1-16.
(2009). working capital management and firm’s profitability optimal cash.