Chartered Financial Analyst (CFA) Level 1 Practice Exam

What is assessed by the cash conversion cycle?

1. The efficiency of cash management

2. The effectiveness of debt structure

3. The short-term liquidity position

4. The time taken to convert investments back into cash

The correct answer is: The time taken to convert investments back into cash

The cash conversion cycle is a crucial metric that assesses the time it takes for a company to convert its investments in inventory and accounts receivable into cash flow from sales. This cycle is comprised of three primary components: the days inventory outstanding (how long inventory is held before being sold), the days sales outstanding (how long it takes to collect payment after a sale), and days payable outstanding (how long the company takes to pay its suppliers). By focusing on the duration of these components, the cash conversion cycle directly indicates the efficiency with which a business turns its resources into cash. A shorter cash conversion cycle signifies that a company is able to recover its cash investment more quickly, which is essential for maintaining liquidity, funding operations, and reinvesting in growth opportunities. The other options involve different financial metrics or concepts that do not specifically relate to the conversion of operational investments into cash. The cash management efficiency, debt structure effectiveness, and short-term liquidity position are important aspects of financial analysis, but they address different dimensions of a company’s financial health that are not encapsulated by the cash conversion cycle directly.