Working capital is a timing problem

Learning goals

• Calculate cash conversion and compare liquidity measures consistently.
• Evaluate funding and working-capital trade-offs beyond a single ratio.

Draft · approximately 45 minutes, excluding further revision.

Follow cash through inventory, collection and payment

Using consistent average balances and a 365-day year, DIO=average inventory/COGS×365; DSO=average receivables/credit sales×365; DPO=average payables/credit purchases×365. The cash conversion cycle is DIO+DSO−DPO. COGS is sometimes used as a purchases proxy, but state that approximation. A shorter cycle can release funding, yet may reflect inventory shortages, stricter customer credit or stressed supplier payments.

Seasonality and growth can make year-end ratios misleading. Compare peers with similar business models and accounting choices, then test the cash-flow calendar. A negative cycle can be sustainable when customers pay before suppliers, but does not prove the firm can meet every liability.

Liquidity has quality and availability

Current ratio=current assets/current liabilities. Here quick ratio=(cash+short-term marketable securities+receivables)/current liabilities, excluding inventory and prepayments; cash ratio includes only cash and those securities. Different definitions must be reconciled. Restricted cash, doubtful receivables or obsolete inventory can make reported assets poor sources of near-term payment. Profitability and liquidity answer different questions.

Operating cash, genuinely available credit facilities and marketable securities are normal liquidity sources; asset sales or restructuring may be secondary responses with time and price costs. Aggressive short-term funding can reduce apparent cost while raising rollover risk. A 2% discount for payment on day 10 instead of day 30 implies a simple annualized cost of foregoing it of [0.02/0.98]×365/20≈37.24%; do not compare that directly with a loan until fees, compounding and funding availability are aligned.

Formula and assumptions

CCC=DIO+DSO−DPO; current ratio=CA/CL; quick=(cash+marketable securities+receivables)/CL

A cash-cycle and liquidity comparison

1. DIO=40, DSO=30, DPO=35 days gives CCC=35 days. At unchanged activity, reducing DSO to 25 releases five days of sales-related financing.
2. Current assets=300, including cash 40, marketable securities 20, receivables 100 and other current assets 140; current liabilities=200. Current ratio=1.5, quick=0.8, cash ratio=0.3 under the stated definitions.
3. Investigate restrictions, recoverability and due dates before concluding the 1.5 ratio means payment capacity is comfortable.

Calculation lab

Errors to catch

• Using sales rather than purchases or an explicit proxy for payables days.
• Equating positive profit or a high current ratio with cash availability.

Original knowledge check

Answer every question before checking. Review explanations after submitting; retry starts a new attempt.

Sources and coverage status

These original lessons are drafts. Public outlines are used to check scope; the official learning-outcome text and proprietary question banks are not reproduced here. Follow the source for exam-year requirements and updates.

• Reference · www.cfainstitute.org
• Reference · www.investor.gov