Proper planning is also extremely fundamental to proper management of working capital. Although working capital situations can vary, arranging adequate, longer-term financing can help a company cope with varying situations. When the long-term financing sufficiently covers the total capital requirement leaving excess funds, the firm has surplus cash available for short-term investment. Thus the amount of long-term financing raised, given the total capital requirement, determines whether the firm is a short-term borrower or lender (Brealey et al, 349). There is little doubt that proper planning, including regular cash flow forecasting, can prevent unexpected cash shortfalls. To be sure, cash flow forecasting is not the easiest of tasks, yet it plays an important role in the success or survival of a business.
When thinking about how to make the best use of the cash conversion cycle, all a person has to do is remember: "it begins in the fundamentals" (Kuczmarski). Why do the fundamentals matter when just a few years ago every stock went upwards? Well in the end, a solid company with strong fundamentals and a management team that is consistent and accountable to its investors will likely remain a good long-term company. In other words, your average S&P 500 blue-chip firm will likely still be around and their business will, to some degree, grow whether in an up or down market.
The cash conversion cycle (a.k.a. net operating cycle) is a combination of both general and abstract ratio trends. It is a telling statistic indicating how cash is moving throughout a company in terms of duration. In essence, this ratio is vital because the cycle represents the number of days a firm's cash remains tied up within the operations of the business. The cash conversion cycle can be constructed using the three ratios that compose the formula. These take a close look at the firm's inventory, receivables and payables:
Cash Conversion Cycle Average Inventory Collection Period
(Or net operating cycle) = + Average Receivables Processing Period
Average Payables Period
