Chartered Financial Analyst Level 1

Chartered Financial Analyst Level 1

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An analyst gathers the following information about a company: Year 2 Year 1 Days of inventory on hand 11 13 Days of sales outstanding 24 22 Payables turnover 36 18 Based solely on the cash conversion cycle, the company's liquidity position from Year 1 to Year 2 has:

Explanation:

The cash conversion cycle (CCC) is calculated as:

CCC=Days of Inventory on Hand (DOH)+Days of Sales Outstanding (DSO)−Number of Days of PayablesCCC = \text{Days of Inventory on Hand (DOH)} + \text{Days of Sales Outstanding (DSO)} - \text{Number of Days of Payables}

Calculation for Year 1:

  • Number of Days of Payables = 365 / Payables Turnover = 365 / 18 ≈ 20.2778
  • CCC = 13 (DOH) + 22 (DSO) - 20.2778 ≈ 14.7222

Calculation for Year 2:

  • Number of Days of Payables = 365 / 36 ≈ 10.1389
  • CCC = 11 (DOH) + 24 (DSO) - 10.1389 ≈ 24.8611

Analysis: The CCC increased from 14.7222 in Year 1 to 24.8611 in Year 2, indicating a longer cycle. A longer CCC suggests lower liquidity, meaning the company's liquidity position deteriorated.

Why B and C are Incorrect:

  • B ignores the change in the number of days of payables, leading to an incorrect conclusion of unchanged liquidity.
  • C incorrectly uses the payables turnover directly in the CCC calculation, resulting in a misleading improvement in liquidity.
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