Asset Conversion Cycle Calculations

The Asset Conversion Cycle (ACC) calculations portray the number of days a business takes to purchase
raw materials, convert those materials into finished goods and services, sell them, and receive payment.
The ACC has three parts:
1.Accounts Receivable Turnover Days
2.Inventory Turnover Days
3.Payables Turnover Days

The word formula looks like this: Accounts Receivable Turnover Days + Inventory Turnover Days -
Accounts Payable Days. The calculations for each are as follows.
Accounts Receivable Turnover Days: This calculation represents the number of days from the sales of
goods and services to payment: (Accounts Receivable / Sales X 365). Example: $2 million in annual sales
and $200,000 in accounts receivables at the end of the year equals a 36.5 Account Receivable Turnover
days.

Inventory Turnover: This calculation measures the time between the purchase of raw materials and the
sales of products produced from those materials: (Inventory / Cost of Goods Sold (COGS) X 365).
Example: COGS is $1.2 Million with a year-end inventory of $164,000 equaling an Inventory turnover
days of 50. ($164,000 / $1,200,000 X 365) = 50 days.

Payables Turnover: This formula calculates in days the average length of time between the purchase of
goods and services and the payment of them. (Accounts Payable / COGS x 365). Example: $182,400 is
the accounts payable balance and again the COGS of $1.2 million resulting in an accounts payable days
of 55.5. ($182,400 / $1,200,000 X 365) = 55.5 days.

Asset Conversion Cycle Result: The ACC result from the above calculations would look like this:
Accounts Receivable Turnover Days (36.5) plus the Inventory Turnover Days (50) minus the Payables
Turnover (55.5). The ACC result is 31 days.

But what does this mean? By comparing the calculated ACC of the borrower with other companies, the
lender can gain a perspective of the health of that company. The Dunn & Bradstreet Comprehensive
report from SS&C's BancMall can supply these numbers to the lender for both the prospective borrower
and peers.

ASSET CONVERSION CYCLE ( influences the amount of financing required by your business)

The Asset Conversion Cycle usually referred to as the Cash Conversion Cycle or Cash Cycle is an
important analysis tool that allows the credit analyst to determine more easily why and when the
business needs more cash to operate, and when and how it will be able to repay the cash. It is also used
to distinguish between the customer's stated loan purpose and the borrowing cause. Once the cash
conversion cycle for the borrower is mapped, the analyst is able to judge whether the purpose,
repayment source and structure of the loan are the adequate ones. Managing asset conversion in favor
of the business owner is the ultimate goal of transportation logistics and techniques such as just in time
inventory. The Asset Conversion Cycle represents (1) the number of days it takes a company to purchase
raw materials, (2) convert them into finished goods, (3) sell the finished product to a customer and
receive payment from the customer / account debtor for the product. The ACC has three components
(Accounts Receivable Turnover Days, Inventory Turnover Days and Payables Turnover Days). At its
simplest expression the asset conversion cycle of a company is defined by the sum of the Accounts
Receivable Turnover Days and the Inventory Turnover Days subtracting the Accounts Payable Days.


First lets look at how these numbers are calculated:

1- Accounts Receivable Turnover in Days. Measures the average number of days from the sale of goods
to collection of resulting receivables. It is obtained by the following formula: ( Accounts Receivable /
Sales X 365). For example, A fictional manufacturer of widgets: "Red Widget Co." with annual sales of
$5,000,000 and with accounts receivable outstanding of $500,000 at the end of the year is said to have a
36.5 Account Receivable Turnover in days.

( $500,000 / $5,000,000 ) X 365 = 36.5 days

2- Inventory Turnover. Measures the length of time on average between acquisition and sale of
merchandise. For a manufacturer it covers the amount of time between purchase of raw material and
sale of the completed product. It is obtained by the following formula: (Inventory / COGS X 365). Going
back to our fictional manufacturer of widgets "Red Widget Co." let's suppose that the company had a
COGS of $3,000,000 with inventory of $411,000 at the end of the year. It would be said that Red Widget
Co. has Inventory turnover days of 50.

( $411,000 / $3,000,000 ) X 365 = 50 days

3- Payables Turnover in Days. Measures the average length of time between purchase of goods and
payment for them. It is obtained by the following formula: (Accounts Payable / COGS x 365 ).

This time "Red Widgets Co." has an accounts payable balance of $456,000 at the end of the year. The
result is an accounts payable days of 55.5 ( $456,000 / $3,000,000 ) X 365 = 55.5 days

In the case of Red Widget Co. the Cash Conversion Cycle is 31 days.( 36.5 + 50 - 55.5 ).

Now you may ask yourself why are you doing all that math? Is it just to come up with a number that
doesn't really tells you anything?

To tell you the truth, in real life once you enter the financial information into the software, the
computer spits out dozens of ratios most of which are not paid any attention. However, we always look
at the cash conversion. We have to because most businesses are not disciplined enough to keep control
over the collection of receivables, the managing of inventory or using vendor financing to its fullest. In
fact, we will not only look at your ratios, but having access to industry averages, we will compare your
company to your competitors and determine how well you are running your company in respect to your
peers. Managing your asset conversion affects your bottom line, your cash flow andinfluences the
amount of external financing needed by your business

COGS = Beginning Inventory for period plus Direct material purchases + Direct Labor + Cost of Total
Goods
Available for Sale (minus) Ending Inventory = COGS