Inventory period

Accounts receivable period

Cash cycle -


Cash paid for inventory

Cash received

Operating cycle

The operating cycle is the time period from inventory purchase until the receipt of cash. (The operating cycle may not include the time from placement of the order until arrival of the stock.) The cash cycle is the time period from when cash is paid out to when cash is received.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VII. Short-Term Financial Planning and Management

1S. Short-Term Finance and Planning

© The McGraw-Hill Companies, 2002

PART SEVEN Short-Term Financial Planning and Management

Learn more about outsourcing accounts management at www.businessdebts.com and

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The gap between short-term inflows and outflows can be filled either by borrowing or by holding a liquidity reserve in the form of cash or marketable securities. Alternatively, the gap can be shortened by changing the inventory, receivable, and payable periods. These are all managerial options that we discuss in the following sections and in subsequent chapters.

Internet-based bookseller Amazon.com provides an interesting example of the importance of managing the cash cycle. By mid-2001, the market value of Amazon.com was higher than (in fact almost twice as much as) that of Barnes & Noble, king of the brick-and-mortar bookstores, even though Barnes & Noble's sales were 50 percent greater than Amazon's. In fact, Amazon had never earned a profit and most likely would not until the year 2002. Meanwhile, Barnes & Noble had been solidly profitable for the third consecutive year.

How could Amazon.com be worth so much more? There are several important factors to consider. First, Amazon turns its inventory over about 14 times a year, 7 times faster than B&N, so its inventory period is dramatically shorter. Even more striking, Amazon charges a customer's credit card when it ships a book, and it usually gets paid by the credit card firm in a day. However, Amazon meanwhile takes up to several weeks to pay its suppliers. This means Amazon has a negative cash cycle! Every sale therefore generates cash inflow that can be put to work immediately. Amazon plans to stretch its cash cycle even further as it uses its growing buying power to repay publishers even more slowly, according to the firm's CFO.

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