Cash Conversion Cycle and its Impact upon Firm Performance: an Evidence from Cement Industry of Pakistan

Abstract

Introduction In contemporary global and competitive environment, the sustainability remains dependable on the ability and success of financial management function. In the financial market it became a challenge for a financial manager that how to respond the dynamics of financial markets (Padachi, 2006). The survival of a firm not only depends on how one can efficiently and effectively pursue for its financing and investing opportunities in national and international financial markets' but also how one is managing the financial and operational affairs of the firm. The long run survival can only be possible through efficient management of cash conversion cycle including receivable collection period, inventory conversion period and payable deferral period (Weinraub & Visscher, 1998). The efficient use of funds along with efficient operations management is the critical area of financial affairs of a firm. According to Jose and Stevens (1996) cash conversion is a comprehensive measure related with the management of account receivables, management of inventory as well as the management of account payables. The importance of the management of current assets and short term liabilities cannot be ignored in any organization. Researchers all over the world discuss this issue in detail in the perspective of different economies. As far as dev eloping countries are concerned, management of current assets i.e. inventories and account receivables and management of short term liabilities are considered as a life blood for organization. The cash conversion cycle is a result of time taken by the firm for their collection from receivables and time required to convert raw material into finished goods after subtracting the time taken by the firm to pay its current obligation (Deloof, 2003; Lazaridis & Tryfonidis, 2006). The sum of inventory conversion time and the time required to collect amount from customers define the firms operating cycle (Uyar, 2009). The concept of operating cycle become deficient due to ignoring the time dimension of current liability commitments which is useful for cash flow measurement and liquidity requirement of the firm (Richards & Laughlin, 1980). Cash conversion cycle is a comprehensive performance measure used for reviewing the ability of companies in managing their capital. Cash conversion cycle indicate the efficiency of management of current assets. Shorter the time of cash conversion allows the firms to generate more sales from the amount invested, which shows that business utilized their resources for generating maximum profit (Moss & Stine, 1993). Cash conversion cycle for a manufacturing company can be defined as a function of [days of accounts receivable + days of inventory--days of accounts payable] (Deloof, 2003; Lazaridis & Tryfonidis, 2006). The receivable collection period measures the average number of days from the sale of goods on credit to collection from account receivables. It is calculated as [(account receivables/sales) *365]. The inventory conversion period contain the time required for the conversion of raw material into finished goods. It is calculated as [(inventory/cost of goods sold*365]. The payable deferral period is the average time needed to purchase goods on credit and final payment for them. It is calculated as [(account payable/cost of goods sold) *365]. The length of cash conversion cycle is used to measure the impact of accounts receivable, inventories and payments to supplier on the firm's profitability, cash conversion cycle assist in measuring the performance and current assets management of the firm's (Uyar, 2009). Firms experiencing a shorter time span of cash conversion cycle will be able to increase the profitability by managing its credit policy and increasing its inventory levels, while firms having a relatively large length of cash conversion cycles should focus on reducing the investment in the components of working capital. …

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