(a) Give the meaning of cash conversion cycle. (b) How does the nature of business influence its cash conversion cycle? Explain with the help of a diagram.

Question

Accepted Answer

(a) **Cash Conversion Cycle (CCC)** is the time period between the cash outflow for purchasing raw materials or inventory and the cash inflow from the collection of accounts receivable. It reflects how long a business's cash remains tied up in its operating activities.

(b) The **nature of business** significantly influences the CCC:

**Trading Business:** The CCC is shorter because the business buys ready-made goods and sells them directly. The cycle is: Cash → Stock of Goods → Sales → Debtors → Cash. There is no manufacturing stage, so the cycle is simpler and quicker.

**Manufacturing Business:** The CCC is longer because the business must purchase raw materials, process them into finished goods, and then sell them. The cycle is: Cash → Raw Material Stocks → Work in Progress → Finished Goods → Sales → Debtors → Cash. The additional production stages increase the time cash is locked in operations.

**Service Business:** The CCC may be very short or even negative if services are paid for in advance or at the time of delivery.

**Diagram for a Manufacturing Business:**
Cash → Raw Material Stocks → Work in Progress → Finished Goods → Sales → Debtors → Cash

The longer and more complex the production process, the more working capital the business requires to sustain its operations.