Cash Conversion Cycle
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CPA Auditing and Attestation (AUD) › Cash Conversion Cycle
All of the following are valid reasons for a business to hold cash and marketable securities, except to:
Earn maximum returns on investment assets
Maintain a precautionary balance
Satisfy compensating balance requirements
Maintain adequate cash needed for transactions
Explanation
The three primary motives for holding cash are transaction demand, precautionary demand, and speculative demand.
A company has total costs of \$100,000, of which 40% is variable costs. What is the operating leverage?
2.5
0.6
1.5
0.4
Explanation
Operating leverage is calculated as fixed costs divided by variable costs. If 40% of \$100,000 are variable costs, the remaining \$60,000 must be fixed costs. Thus, $60,000/$40,000=1.5.
As a company becomes more conservative with respect to working capital policy, it would tend to have a(n):
Increase in the ratio of current liabilities to noncurrent liabilities
Decrease in the quick ratio
Decrease in the operating cycle
Increase in the ratio of current assets to noncurrent assets
Explanation
An increase in the ratio of current assets to non-current assets would be indicative of an increasingly conservative working capital policy.
Each of the following items is included when computing a firm's target cash conversion cycle, except the:
Days of payables outstanding
Cash discount period
Days in inventory
Days sales in accounts receivable
Explanation
The cash conversion cycle does not include the cash discount period. Cash discounts would be considered as a component of receivables collections and payables deferrals.
An increase in sales collections resulting from an increased cash discount for prompt payment would be expected to cause a:
Increase in the operating cycle
Increase in the average collection period
Decrease in the cash conversion cycle
Increase in bad debt issues
Explanation
An increase in sales collections would decrease the cash conversion cycle.
The cash conversion cycle is the length of time from an initial expenditure for production to the date:
Cash is paid to employees for production
Cash is collected from customers offset by the length of time it takes to pay vendors
Cash is recorded on the books
Cash is collected from suppliers
Explanation
This is the definition and purpose of the cash conversion cycle which exists to quantify a firm's ability to generate cash flow.