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about $35 million ($18.9 million per day x 37 days x 5%) per year. In this way, a reduction in the cash conversion cycle drops directly to the bottom line.
But even better, the year over year trend in the cash conversion cycle often serves as a sign of business health or deterioration. Declining DSO means customers are paying sooner; conversely, increasing DSO could mean the company is using credit to push product. A declining DIO signifies that inventory is moving out rather than "piling up." Finally, some analysts believe that an increasing DPO is a signal of increasing economic leverage in the marketplace. The textbook examples here are Wal-mart and Dell: these companies can basically dictate the terms of their relationships to their vendors and, in the process, extend their days payable (DPO).
Looking "Under the Hood" for Other Items
Most of the other working capital accounts are straightforward, especially the current liabilities side of the balance sheet. But you do want to be on the alert for the following:
• Off-balance sheet financing. • Derivatives.
For examples of these two items, consider the current assets section of Delta Airlines' fiscal year 2003 balance sheet:
Notice that Delta's receivables more than doubled from 2002 to 2003. Is this a dangerous sign of collections problems? Let's take a look at the footnote:
We were party to an agreement, as amended, under which we sold a defined pool of our accounts receivable, on a revolving basis, through a special-purpose, wholly owned subsidiary, which then sold an undivided interest in the receivables to a third party.... This agreement terminated on its scheduled expiration date of March 31, 2003. As a result, on April 2, 2003, we paid $250 million, which represented the total amount owed to the third party by the subsidiary, and subsequently collected the related receivables. (Note 8, Delta 10K FY 2003)
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