# Supply Chain Project

## SCM432

### How to Calculate The Cash To Cash Cycle

So far, we have talked conceptually about the C2C, but we have not learned to calculate it yet.  Here is an example of computing the C2C:

• •         Example

–        A/R DOH = 45 days

–        Inv DOH = 60 days

–        A/P DOH = 30 days

–        C2C = 45 + 60 – 30 = 75 days (Takes and average of 75 days to get cash spent and back into the firm)

A/R DOH stands for accounts receivable days on hand.  A/R DOH shows the amount of accounts receivable available that supports the sales of the firm.  As stated earlier, accounts receivable can grow due to the growth in sales and/or loosening of credit policies for customers.  As general rule, one would desire a proportional growth in receivables with the growth in sales.  For example, a 10% growth in sales would possibly need a proportional growth in receivables of 10% to support the sales growth.  One would not want a growth in A/R and have a downturn in sales growth, because this would indicate the a business is not collecting it’s A/R.  The decrease in sales decreases cash in the firm, and the A/R DOH increasing ties up working capital, which also decreases available cash.

One can compute A/R DOH in several ways:

Formula One:  A/R DOH = Average A/R/Sales *365 days

Formula Two:  First, calculate receivable turnover, which is the number of times A/R turns in year. Next, divide the number of days in a year by the receivables turnover.

Receivables Turnover = Sales/Average A/R

A/R DOH = 365/Receivables Turnover

Both formulas will give the same answer.

Example:

Sales – 1,000

Ave. A/R – 200

Formula One: 200/1000 *365 = .2 *365 = 73 A/R DOH

Formula Two:

Receivable Turnover = 1000/200 = 5

A/R DOH = 365/5 = 73

Inv DOH stands for inventory days on hand.  This shows the amount of inventory available to support daily sales.  Inventory is listed on the balance sheet at cost, so we use the cost of goods sold to reference the amount of inventory available; in essence we compute Inv DOH based on cost of goods sold rather than the sales price.  Like with A/R DOH, we just enough inventory to support sales and not too much.  Increases in inventory should correlate with increases in sales; one would not want inventory increasing or remaining the same and sales decreasing.

One can compute Inv DOH in the same manner as A/R DOH, except we use cost of goods sold (COGS) rather than sales:

Formula One:  Ave. Inventory/COGS *365

Formula Two:  COGS/Ave. Inventory = Inventory Turnover

Inv DOH = 365/Inventory Turnover

Example:

COGS – 500

Ave. Inventory – 100

Formula One – 100/500 = .2*365 = 73

Formula Two – 500/100 = 5 (Inventory Turns)

Inv. DOH = 365/5 = 73

A/P DOH stands for accounts payable days on hand.  This shows the amount of time it takes a business to pay its suppliers.  Accounts payable (also known as “trade credit”) is listed at cost on the balance sheet, so we COGS to reference the time the business takes to pay suppliers.  Unlike A/R and inventory, many business like a high amount of A/P because delays in disbursements make more cash available to a firm.  In the cases of the C2C, an extended accounts payable actually increases cash.  The problem here is that business can lose trade credit, which is essence interest-free financing if they do not pay suppliers according to payment terms.  This loss of trade credit would impact the cash position of the firm greatly, because the firm would need much more working capital cash to operate.  A firm needs good supplier relationship management to keep suppliers happy and keep trade credit intact.

To compute A/P DOH:

Formula One: Ave. A/P/COGS *365

Formula Two:

A/P Turnover: COGS/Ave. A/P

A/P DOH = 365/A/P Turnover

Example:

COGS – 500

Ave. A/P = 100

Formula One:  100/500*365 = .2*365 = 73 (A/P DOH)

Formula Two

A/P Turnover = 500/100 = 5

A/P DOH = 365/5 = 73

We can now calculate the C2C from our examples, which is:

73 + 73 -73 = 73 days.  This means that it takes 73 days to cash back from the time we pay for merchandise to the time we collect on the sale.

Adding the A/R and inventory together gives us what is called the operating cycle.  So, the C2C is the difference between how long it takes us to operate and collect the cash.

If the C2C is positive, this is also the amount of working capital that needs to be financed.  As we stated earlier, working capital is financed by a combination of short-term debt (A/P and short-term financing) long-term financing and equity.  The longer the C2C, the more financing that is required.  Changes in the C2C serve as an early warning measure.  A lengthening of the C2C can indicate that the firm is having trouble moving inventory, or collecting its receivables.  A high A/P DOH can mean excessive use of trade credit, which could strain relationships with suppliers.  We have learned based on the aforementioned information that the supply can positively affect the C2C, and can impact the business in a profound manner.