Tuesday, October 27, 2009

Financial Accounting II - Understanding the Story Behind Accounts

In our Financial Accounting class today (we have a new professor, Francesco Bova) and although Franco Wong (no relation) was a great professor, the material in Financial Accounting II is more "practical" building on the foundations in Fin Acc I (where we were learning mechanics of accounting).

We began by discussing cash cycle as composed of days [inventory, receivables, payables]. However, Francesco posed an interesting question: "Is it possible to have a negative cash conversion cycle?" (in the same way I had asked Prof. Franco Wong if it is possible to have a negative LIFO reserve). The answer is 'yes', but with special conditions:

Recall:
Cash Conversion Cycle = Days Inventory + Days Receivables - Days Payables

So for Cash Conversion Cycle to be negative:
  • Days Inventory should be smaller
  • Days Receivables should be smaller
  • Days Payable should be higher
When is this the case? Look at Dell computers:
  • JIT Inventory - Extremely low Days Inventory (inventory only used as needed / ordered)
  • Visa and cash payments - Extremely low Days Receivable (is paid fairly immediately to Dell. It's A/R for Visa)
  • Days Payable - Standard terms to suppliers
Because of these unique relationships, (which also exists in construction where revenue and cash is often recognised earlier and then placed in a treasury bond to gain interest) and is known as stretching payables. This is the act of investing cash which is dormant in a negative cash conversion cycle to make some interest income.

2 comments:

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rlabey said...

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Accounting For Business