Cash Conversion Cycle
The Cash Conversion Cycle, also known as CCC, is a financial metric used to calculate the length of time it takes for a company to convert its investments into cash. CCC is a measure of the number of days it takes to convert a company’s investments in inventory and accounts receivable into cash, minus the number of days the company takes to pay its own bills (accounts payable).
It measures the efficiency of a company’s cash flow and helps businesses understand how long it takes to convert sales into cash. The CCC metric is critical for businesses to assess their liquidity and cash flow performance.
The Cash Conversion Cycle (CCC) Formula
The formula to calculate the Cash Conversion Cycle (CCC) involves three key components:
CCC = DIO + DSO – DPO
- Days Inventory Outstanding (DIO) – measures the number of days it takes the company to convert its inventory into sales.
DIO = (Average Inventory / Cost of Goods Sold) x 365
- Days Sales Outstanding (DSO) – measures the number of days it takes the company to collect its accounts receivable from customers.
DSO = (Average Accounts Receivable / Annual Credit Sales) x 365
- Days Payable Outstanding (DPO) – measures the number of days it takes the company to pay its vendors and suppliers for goods purchased.
DPO = (Average Accounts Payable / Cost of Goods Sold) x 365
Example of Cash Conversion Cycle (CCC)
Let’s assume a company has an average inventory value of $50,000, cost of goods sold at $200,000, average accounts receivable of $30,000, annual credit sales of $150,000, and accounts payable of $20,000.
Using the formulas for DIO, DSO, DPO, we can calculate the following:
DIO = ($50,000 / $200,000) x 365 = 91.25 days
DSO = ($30,000 / $150,000) x 365 = 73 days
DPO = ($20,000 / $200,000) x 365 = 36.5 days
CCC = DIO + DSO – DPO = 91.25 + 73 – 36.5 = 127.75 days
Hence, the company takes approximately 128 days, on average, to convert its investments in inventory and accounts receivable into cash.
Why Is Cash Conversion Cycle (CCC) Important
The Cash Conversion Cycle (CCC) metric helps businesses with:
- Liquidity: The CCC is an essential measure of the company’s liquidity, indicating how long it takes to convert inventory and accounts receivable into cash to pay bills.
- Cash Flow Management: The CCC helps to manage cash flow more efficiently by identifying areas that cause delays in the conversion of cash.
- Inventory Management: The CCC helps in managing inventory levels, as businesses can lower inventory levels to minimize the length of time inventory sits unsold.
Accounts Receivable Management: The CCC helps in managing accounts receivable by sending timely invoices and following up on overdue accounts.