5 Questions
What is the purpose of constructing a timeline for a company's operating cycle using the average duration of short-term accounts?
The purpose is to understand the company's cash conversion cycle, which is the amount of time between paying suppliers and receiving cash from customers.
What are the three components that make up the cash conversion cycle, and how are they defined?
The three components are: days payable outstanding (DPO), days of inventory on hand (DOH), and days sales outstanding (DSO). DPO is the amount of time accounts payable are outstanding, DOH is the amount of time inventory is held, and DSO is the amount of time accounts receivable are outstanding.
How is the cash conversion cycle formally expressed in terms of the three components?
The cash conversion cycle, in days, is expressed as: Cash conversion cycle = Days of inventory on hand + Days sales outstanding - Days payable outstanding.
Why are the activity ratios (DPO, DOH, and DSO) important for analysts to understand?
The activity ratios are important for analysts because they provide insight into the company's operating cycle and cash conversion cycle, which are key indicators of the company's liquidity and efficiency.
How can the cash conversion cycle be used to evaluate a company's financial performance and management of its working capital?
The cash conversion cycle can be used to evaluate a company's financial performance and management of its working capital because it provides a measure of how efficiently the company is managing the timing of its cash inflows and outflows. A shorter cash conversion cycle generally indicates more efficient working capital management.
Learn about constructing a timeline for a company's operating cycle using the average duration of short-term accounts, and understand activity ratios such as days payable outstanding (DPO), days of inventory on hand (DOH), and days sales outstanding (DSO). This concept is crucial for financial analysis and management decisions.
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