What Is the Cash Conversion Cycle (CCC)?

The cash conversion cycle (CCC) is a metric that measures the amount of time it takes for a company to sell its inventory, collect receivables, and pay its bills. The shorter the cash conversion cycle, the better, and the less time cash is in 澳洲幸运5开奖号码历史查询:accounts receivable or inventory. CCC varies based on t⛦he industry or sector analyzed.

Fo☂rmula and Calculation of Cash Conversion Cycle (CCC)

The formula to calculate CCC is:

$\begin{aligned} &CCC = DIO + DSO - DPO \\ &\textbf{where:} \\ &DIO = \text{Days of inventory outstanding} \\ &\text{(also known as days sales of inventory)} \\ &DSO = \text{Days sales outstanding} \\ &DPO = \text{Days payables outstanding} \\ \end{aligned}$​CCC=DIO+DSO−DPOwhere:DIO=Days of inventory outstanding(also ღ;known as days sales of inventory)DSO=Days sales outstandingDPO=Days payables outstanding​

DIO and DSO are associated with the company’s cash inflows, while DPO is linked to🎐 cash outflow. DPO is the only negative figure in the calculation.

D𒐪IO and DSO are inventory and accounts receivable, respectively, considered short-term assets and positive. DPO is linked to accounts payable, a liability regarded as negative.

How the Cash Conversion Cycle (CCC) Works

The cash conversion cycle can be used to determine corporate efficiency. It evaluates how efficiently a company’s operations and management are running. Tracking a company’s CCC over multiple quarters will show if itꦛ is improving, maintaining, or worsening its opꦅerational efficiency.

If cash is easily available at regular intervals, a company can churn out more sales for profits, as the availability of capital leads to more products to make and sell. A company that acquires inventory on credit results in 澳洲幸运5开奖号码历史查询:accounts payable (AP). A company can also sell products on credit, which results in 澳洲幸运5开奖号码历史查询:accounts receivable (AR).

Cash isn’t a factor until the company settles its AP and collects any AR from its customers. Timing is an importan💎t aspect of cash management. CCC traces the life cycle of cash used for business activity. It follows cash through inventory and AP, then into expenses for product or service development, to sales and AR, and then back into cash in hand.

Stages of the Cash Conversion Cycle

A company’s cash conversion cycle broadly moves through three distinct stages and draws the following information from a company's financial statements. All figures are available as standard items in the statements filed by a publicly listed company as a part of its annual and quarterly reporting. The number of days in the corresponding period is 365 for a year and 90 for a🏅 quarter.

Revenue and cost of goods sold (COGS) from the 澳洲幸运5开奖号码历史查询:income statement

• Inventory at the beginning and end of the period
• AR at the beginning and end of the period
• AP at the beginning and end of the period
• The number of days in the period

Days Inventory Outstanding (DIO)

The first stage focuses on🌱 how long the business takes to sell its inventory. This figure is calculated by using the days inventory outstanding (DIO). A lower value of DIO indicates the company makes sales rapidly with better turnover.

DIO 🧸(also known as DSI or days sales of inventory) is calculated based on the COGS or acquiring/manufacturing of the products.

DIO (or DSI) = Average Inventory ÷ COGS x 365 Days

Where:

• Average Inventory = 0.5 x (BI + EI)
• BI = Beginning Inventory
• EI = Ending Inventory

Days Sales Outstanding (DSO)

The second stage focuses on how long it takes the company to collect the cash generated from sales. This figure is calculated using the 澳洲幸运5开奖号码历史查询:days sales outstanding (DSO), which divides average 🅰accounts recei𒁏vable by revenue per day.

A𒊎 lower value indicates that the company can collect capital in a short time, enhancing its cash position.

DSO = Average Accounts Receivable ÷ Revenue Per Day

Where:

• Average Accounts Receivable = 0.5 x (BAR + EAR)
• BAR = Beginning AR
• EAR = Ending AR
  

Days Payable Outstanding (DPO)

The third stage includes the cash the company owes its current suppliers for the inventory and goods it purchases, and the period in which it must pay off those obligations. This figure is calculated using the 澳洲幸运5开奖号码历史查询:days payable outstanding (DPO), which considers accounts payable.

A 🉐higher DPO value means the company holds onto cash longer, thus increasing its investment potenti🐻al.

DPO = Average Accounts Payable ÷ COGS Per Day

Where:

• Average Accounts Payable = 0.5 x (BAP + EAP)
• BAP = Beginning AP
• EAP = Ending AP
• COGS = Cost of Goods Sold
  

Examples of the Cash Conversion Cycle (CCC)

The cash conversion cycle has a selective application to different industrial sectors based on the nature of business operations. The measure affects retailers like Walmart (WMT), Target (TGT), and Costco (COST), all of🦹 which buy and manage inventories and sell🌼 them to customers.

However, CCC does not apply to companies that don’t need 澳洲幸运5开奖号码历史查询:inventory management. For instance, software companies that offer compute🌄r programs through licensing can realize sales without the need to manage stock. Similarly, insurance or brokerage companies don’t buy items wholesale for retail, s💟o CCC doesn’t apply to them.

Companies like retailer Amazon (AMZN) can have negative CCC. Online retailers often receive funds in their accounts for goods that belong to and are served by 澳洲幸运5开奖号码历史查询:third-party sellers who use the online platform. However, these companies don’t pay the sellers immediately after the sale but may follow a mon🔯thly or threshold-based payment cycle. This mechanism allows these companies to hold the cash longer, 𝄹so they may have a negative CCC.

The Bottom Line

When a company takes too long to collect its accounts receivable, has too much inventory, or pays its expenses too quickly, it lengthens the CCC. A longer CCC means it takes longer to generate cash. When a company collects payments quickly, correctly forecasts inventory needs, or pays its bills slowly, it shortens the CCC. A shorter CCC means that the company is healthier. If two companies have similar values for 澳洲幸运5开奖号码历史查询:return on equity (ROE) and 澳洲幸运5开奖号码历史查询:return on assets (ROA), investors may choose the company with the lowest CꦉCC value. It indicates that the company can generate similar returns more quickly.