Are the above terms interrelated? Let me tell you a short story.
Shortly before my MBA program, my job granted me the privileged to be a part of the account team to interface with external auditors during the year-end financial statement audit exercise. Hence, we needed to provide any information the auditors required.
An example was the inventory reconciliation report. I needed to do a report showing the movement of the different products in inventory from the beginning of the year to what the closing balances were. The formula for arriving at that is:
Opening Inventory +Total Purchases – Total Sales – adjustments = Closing inventory
This got me thinking about how to extract the data required for the report, although it was available on the Enterprise Resource Planning (ERP) software – Microsoft Dynamics Navision. But the question was how?
The Head of Account was on leave during that period, so the Management Accountant had to fill in for her. This required me to handle some management accountant role together with mine – Treasury Officer.
Back to my story, I got the cost book (Excel file) that contained the breakdown of all the purchases made. I also downloaded the total sales, balances at the beginning and the end of the period from the ERP. After collating all the required data, I started my manual analysis by exploring all the excel skills I had. For three whole days, I was still analyzing, especially for the products with high volume.
Eventually, I got stuck and had to mount pressure on the Management Accountant to provide clarity despite his busy schedule. What happened next was mind-blowing.
As managers, it is not enough to say we are always busy. There is a need to constantly pause to analyze performance to know if we are in business or busyness.
We are currently discussing ratio analysis in Corporate Financial Accounting, and it is amazing what the figures in the financial statement mean. Let me talk about an aspect of financial statement analyses.
Cash Conversion Cycle
The Cash conversion cycle is the span between when you make payment to purchase raw materials to when we receive payments from customers for sales made. To ascertain this, we need to know our inventory holding period, days of sales outstanding, and days of payables outstanding. Find a brief description of what these terminologies mean:
Inventory Holding Period (IHP): This is the length of time it takes to sell off inventory.
Days of Sales Outstanding (DSO): This is the amount of time it takes your customers to pay up their liabilities.
Days of Payment Outstanding (DPO): This is the number of days we take to pay our suppliers.
Looking at the above, we can reasonably conclude we would prefer DPO to be longer, but don’t we think this would impact the business reputation.
Also, the fact that revenue is rapidly growing does not necessarily mean the business is doing well. It might as well be a charity case. Therefore, we need to analyze our business to ensure we are on the right track.
Back to my story, the management accountant generated the report with a single click of a button on the ERP. An exercise I could not complete in three days despite the excel skills I thought I had.
I was clearly working hard.
Prove What You Say