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LOS c: Evaluate overall working capital effectiveness of a company, using the operating and cash conversion cycles, and compare its effectiveness with other peer companies.

A)	average days of receivables + average days of inventory – average days of payables.

B)	average days of receivables + average days of inventory + average days of payables.

C)	average days of payables + average days of inventory – average days of receivables.

The cash conversion cycle, also called the net operating cycle is:

The cash conversion cycle measures the length of time required to convert a firm’s cash investment in inventory back into cash resulting from the sale of the inventory. A short cash conversion cycle is good because it indicates a relatively low investment in working capital.

An analyst who is evaluating a firm’s working capital management would be least likely to be concerned if the firm’s:

A)	number of days of inventory is higher than that of its peers.

B)	operating cycle is shorter than that of its peers.

C)	total asset turnover is lower than its industry average.

A shorter operating cycle will lead to a shorter cash conversion cycle, other things equal, which is an indication of better working capital management. Higher days inventory on hand, compared to peer company averages, will lengthen the cash conversion cycle, an indication of poorer working capital management. Good working capital management would tend to increase a firm’s total asset turnover since a given amount of sales can be supported with less working capital (less current assets).

Compared to the prior year, Chart Industries has reported that its operating cycle has remained relatively stable while its cash conversion cycle has decreased. The most likely explanation for this is that the firm:

A)	is relying more on its suppliers for short-term liquidity.

B)	has improved its inventory turnover.

C)	is paying its bills for raw materials more rapidly.

The cash conversion cycle is its operating cycle minus its average days payables outstanding. Therefore, the firm’s average days payables must have increased, a clear indication that the firm is relying more heavily on credit from its suppliers. Improved inventory turnover would tend to increase both the operating and cash conversion cycles. Relaxed credit policies would tend to increase the firm’s operating cycle as receivables turnover would tend to decrease.

Compared to the prior period, a firm has greater days of receivables. The effect on the firm’s cash conversion cycle and operating cycle are most likely a(n):

Greater days of receivables will increase both the cash conversion cycle and operating cycle, other things equal.