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A
to
Cash
Conversion
Liquidity
Cycle
Approach
Analysis
Introduction
Althoughworkingcapitalmanagementreceivesless
attentionin the literaturethanlonger-terminvestment
and financingdecisions,it occupiesthe majorportion
of a financialmanager'stime andattention[9, p. 173].
In part,this simplyreflectsthe repetitivenatureof investmentcommitmentswith relativelyshort life expectancyand rapid transformationfrom one investmentformto another[6, pp. 1-2]. Thetime devotedto
workingcapital management,however,also reflects
RICHARDSAND LAUGHLIN/LIQUIDITY
ANALYSIS
33
34
FINANCIALMANAGEMENT/SPRING1980
receivableand inventoryinvestmentsapproximates
the
these
lengthof a firm'soperatingcycle. Incorporating
asset turnoversinto an operatingcycle conceptof the
currentassetconversionperiodtherebyprovidesa more
realistic,althoughincomplete,indicatorof a firm'sliquidityposition.The operatingcycleconceptis deficient
as a cashflowmeasurein thatit failsto considerthe liquidityrequirements
imposedon a firm by the time
dimension of its current liability commitments.
thetimepatternof cashoutflowrequirements
Integrating
imposedby a firm'scurrentliabilitiesis as importantfor
liquidityanalysis as evaluatingthe associatedtime
patternof cashinflowsgeneratedby the transformation
of its ci rrentassetinvestments.
ANALYSIS
RICHARDSAND LAUGHLIN/LIQUIDITY
35
Inventory
Conversion Period
~~o-~
c __
Operating Cycle
_LCash
Payables
Deferral Period
h
Cash
I
x
0:r :
CD
Conversion Cycle
Outlay
36
FINANCIALMANAGEMENT/SPRING1980
Summary
An examination of conventional,static balance
sheet liquidityratios indicatesthe inherentpotential
for misinterpreting
a firm'srelativeliquidityposition.
The extensionof this traditionalanalysisto include
flowsembodiedin the operatingcycleconceptthrough
receivableand inventoryturnovermeasuresdirects
attentiononly to the timing of a firm's cash inflows
and excludesfrom considerationthe time elementof
its cash outflowrequirements.
Sincecash outflowsare
not synchronizedwith inflows for the typical firm,
such an omission is a seriousdeficiencyin liquidity
analysis. Adopting a payablesturnoverconcept extendsthe operatingcycle analysisto incorporateboth
the relevant outflow and inflow components. The
resultingcashconversioncycle analysisprovidesmore
explicitinsightsfor managinga firm'sworkingcapital
position in a manner that will assure the proper
amountandtimingof fundsavailableto meeta firm's
liquidityneeds.
References
1. Annual Statement Studies, Philadelphia, Robert Morris
Associates, 1977.
37
ANALYSIS
RICHARDSAND LAUGHLIN/LIQUIDITY
1978
1977
1976
1975
Net sales
$1,758
$1,440
$1,213
$1,053
$1,269
$1,030
$ 876
$ 774
192
161
142
132
72
66
63
60
$1,533
$ 225
$1,257
$ 183
$1,081
$ 132
$ 966
$
87
$ 204
$ 158
$ 107
46
283
199
227
209
178
199
147
186
16
11
11
14
$ 702
$ 605
$ 495
$ 393
$ 133
$ 106
72
210
48
151
37
88
33
36
14
16
16
14
$ 429
$ 321
$ 227
$ 161
86
78
*Source:Years 1977and 1978,MartinMariettaCorporationAnnualReportto Stockholders, 1978. Years 1975 and 1976, Martin MariettaCorporation10-K
reportsto the SEC.
StaticRatios:
CurrentRatio
Acid-TestRatio
TurnoverRatios:
ReceivablesTurnover
InventoryTurnover
PayablesTurnover*
CashConversionCycle:
ReceivablesConversionPeriod
InventoryConversionPeriod
OperatingCycle
1978
1977
1976
1975
1.64
1.14
1.88
1.20
2.18
1.26
2.44
1.20
6.21
6.38
7.13
6.34
4.93
7.73
6.81
4.40
8.28
7.16
4.16
8.16
58 days
56 days
114days
57 days
73 days
130days
53 days
82 days
135days
50 days
87 days
137days
50 days
64 days
47 days
83 days
43 days
92 days
44 days
93 days
0.29
0.26
0.22
0.12
38
FINANCIALMANAGEMENT/SPRING1980
1976),pp. 33-54.
8. G. A. Welsch and R. N. Anthony, Fundamentalsof
Financial Accounting, revised ed., Homewood, Ill.,