Ratios and Messages about Profitability and Cash Flow
Q: Can you go over Financing Gap and the increase to 33 days?
A: The Financing Gap in days is defined as accounts receivable days plus inventory days minus accounts payable days.
For Buckeye Beverages, Inc. in 2014 it was 20 days + 18 days – 9 days = 29 days, and in 2015 it was 24 days + 23 days –14 days = 33 days, representing a four-day increase.
The Financing Gap Ratio is the Financing Gap expressed in dollars rather than in days, or operating assets minus operating liabilities, divided by sales. We express the Financing Gap as a percent of sales, just as we express gross profit as a percent of sales, EBITDA as a percent of sales, net income as a percent of sales, etc. so that we can compare these measures relative to sales from one period to the next.
If management is able to maintain the same Financing Gap Ratio from one period to the next, then the only factor contributing to the increase or decrease in the Financing Gap – operating assets minus operating liabilities – itself is sales growth or decline. Sales neutral cash flow from the combined movements accounts receivable, inventory, and accounts payable is zero. If, however, management allows the Financing Gap Ratio to increase, then operating assets minus operating liabilities – the Financing Gap – increases more that it would if only impacted by sales growth. In other words, an increase in Financing Gap Ratio means cash outflow above and beyond the cash outflow due to sales growth alone.
A key management task is to stabilize or decrease the Financing Gap Ratio. If management is successful in reducing the Financing Gap Ratio, it effectively reduces the cash conversion cycle.