A Cash Conversion Cycle Approach To Liquidity

Analysis

Group DAkriti Bajracharya

Ayusha BajracharyaBimash SharmaNancy ShresthaNischal Gautam

Umesh Maharjan

Outline of the presentation

1.Brief introduction

2.Objective of the article

3.Methodology used

4.Findings of the article

5.Conclusion

Introduction

• Verlyn D Richards (Professor of Finance) and Eugene J. Laughlin (Professor of Accounting).

Objective

• Focus on the different approaches, such as traditional approach and the operating cycle concept for the liquidity analysis of the firm, as well as their drawbacks

• Comparison between traditional balance sheet ratios and comprehensive approach to analysis

• To clear out the misinterpretation made by the static liquidity analysis

Methodology

Descriptive

analysis

Uses of secondary data

Findings

• Current ratio and acid-test ratio

Static Liquidity Analysis

• Current Ratio

• Ignores the qualitative differences in liquidity attributes of current assets.

• Responded to the problem by introduction of more restrictive acid test ratio.

• Both static liquidity indicators is limited by their failure to provide adequate information about cash flow attributes of the transformation process within a firm’s working capital position.

• Emphasize essentially liquidation, rather than a going concern approach to liquidity analysis.

Misinterpretation of liquidity position

Current ratio

Acid –test ratio

Operating cycle

Receivable collection period

Inventory holding period

• High receivable & longer collection period longer operating cycle deteriorating liquidity.

• High receivable high current and acid-test ratio improving liquidity.

• Similar in case of inventory.• Drawback do not consider the

liquidity requirement imposed by current liabilities.

Incorrect analysis of liquidity position

Liquidity Management

Cash

Raw material inventory

Finished goods inventory

Receivables

Cash

con

vers

ion

cycl

e

• Different from operating cycle concept

Considers cash outflow requirement in an analysis

• Cash conversion cycle interpretation of liquidity position Impact of longer operating cycle Impact of longer payable deferral period

• Interpretation opposite to static liquidity analysis.

Financial management implication

• Spontaneous and non-spontaneous financing

SpontaneousNon-spontaneous

Working Capital Investment

The need for cash conversion cycle approach

• Length of cash conversion cycle has impact on Financial structure Investment structure

Length of cash conversion cycle

Borrowing capacity

In case of economic uncertainty

Conclusion

Static liquidity analysis

Operating cycle concept

Cash conversion cycle concept

Liquidity Analysis

THANK YOU

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