Chartered Financial Analyst (CFA) Level 1 Practice Exam

How is the cash conversion cycle calculated?

1. Days of sales outstanding

2. Days of inventory on hand + Days of sales outstanding - Days payables outstanding

3. Days of accounts payable

4. Days of cash available

The correct answer is: Days of inventory on hand + Days of sales outstanding - Days payables outstanding

The cash conversion cycle is a key metric used to assess how efficiently a company manages its working capital. It measures the time it takes for a company to convert its investments in inventory and accounts receivable into cash inflows from sales. The calculation of the cash conversion cycle incorporates three main components: 1. **Days Inventory Outstanding (DIO):** This measures the average number of days that inventory is held before it is sold. A lower DIO indicates quicker sales of inventory, which is favorable for cash flow. 2. **Days Sales Outstanding (DSO):** This reflects the average number of days it takes for a company to collect payment after a sale has been made. Shorter DSO values imply that a company is more efficient at collecting receivables, thus positively influencing cash flow. 3. **Days Payables Outstanding (DPO):** This indicates the average number of days a company takes to pay its suppliers. While a higher DPO can be beneficial as it allows the company to hold onto its cash longer, it should not be excessively high to avoid damaging supplier relationships. The formula for the cash conversion cycle is: Cash Conversion Cycle = Days Inventory Outstanding + Days Sales Outstanding - Days Payables Outstanding. In this context, the correct