The cash conversion cycle (CCC) measures how long it takes a company to convert its investments in inventory into cash from sales. It encompasses the time it takes to sell inventory, collect receivables, and pay suppliers.
Primary Implication
The number one law in business is when you are out of cash, you are out of business. The fastest way to violate this law is to try and operate your business model with a slow cash conversion cycle.
A poor cash conversion occurs when you have inadequate sales, faulty budgeting, or poor planning, leading you to spend more money than you can afford.
Overview
What is the cash conversion cycle?
The Cash Conversion Cycle is an Efficiency Ratio that measures the amount of time each net input dollar is tied up in production and sales to customers before it is converted into cash. It is the length of time, in days, that it takes for a company to convert resource inputs into cash flows by selling inventory and collecting receivables. It also considers the length of time the company is afforded to pay its bills without incurring penalties.
The Cash Conversion Cycle can be viewed as a sales efficiency calculation because it shows how quickly a company can buy, sell, and collect on its inventory. This cycle has three distinct parts:
- Current inventory level: how long it will take the company to sell this inventory as measured by days inventory outstanding.
- Current sales: the amount of time it takes to collect the cash from these sales as calculated by days sales outstanding.
- Current outstanding payables: representing how much a company owes its current vendors for inventory purchases, and when the company will need to pay off its vendors, calculated by days payables outstanding.
The formula for calculating the Cash Conversion Cycle
Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding
A cash conversion cycle of 20 means it takes 20 days from paying for inventory to receiving the cash from its sale.
Fewer Days is Better: A small conversion cycle indicates an ability to buy and sell inventory, and then receive cash from customers in less time.
More Days are Worse: This means an extended number of days between paying the vendor for the inventory and receiving the cash from its customers.
