Final answer:
A prolonged cash conversion cycle may lead to financial difficulties, including trade imbalances and high capital inflows or outflows, and may force a company to reduce production or cease operations.
Step-by-step explanation:
When the cash conversion cycle of a company is too long, they risk the chance of missing out on optimizing their cash flow, which can lead to a range of financial difficulties. Companies may face a risk of being stuck with an exchange rate leading to a large trade imbalance and high financial capital inflows or outflows. This could severely impact a company's ability to operate efficiently and manage its financial obligations.
Furthermore, in the long run, companies with prolonged cash conversion cycles might incur losses, which may force them to reduce production or even shut down operations—a process called exit. On top of this, a lengthy cash conversion cycle can exacerbate the asset-liability time mismatch for financial institutions like banks. This might lead to a precarious situation where banks pay more interest to depositors than they receive from borrowers, ultimately threatening the bank's survival.