Question

Which of the following items would cause the cash conversion cycle to decrease?

1) Increasing the days inventory held.
2) Increasing days payable outstanding.
3) Increasing the average collection period.
4) None of the above.

Answer 1

To decrease the cash conversion cycle, a company needs to increase its days payable outstanding, as this extends the time it holds onto its cash. Options increasing days inventory held or the average collection period would actually increase the CCC.

Step-by-step explanation:

The question you've asked pertains to the cash conversion cycle (CCC), which is a metric used in business to measure the efficiency at which a company manages its cash flows pertaining to its operating cycle. The CCC is characterized by three components: days inventory outstanding (DIO), days sales outstanding (DSO), also known as the average collection period, and days payable outstanding (DPO).

The formula for CCC is CCC = DIO + DSO - DPO. To reduce the cash conversion cycle, a company would need to reduce DIO and DSO or increase DPO.

Now, answering your question, to decrease the cash conversion cycle, you'd opt for 2) Increasing days payable outstanding. This change increases the time a company takes to pay its suppliers, thereby holding onto its cash longer, which improves cash flow and decreases the CCC.

Options 1) and 3) would actually increase the CCC because they imply that a company is taking longer to sell inventory and collect receivables, respectively. Hence, the correct answer is 2). By increasing the days payable outstanding, a company can effectively shorten its cash conversion cycle.