The cash conversion cycle (CCC) can help you understand the amount of time it takes to collect cash from sales of your inventory. It is an important tool for small business owners - that is why we've compiled this short guide to making a cash conversion cycle calculation.
CCC - explained
The cash conversion cycle describes an important business metric identifying the number of days it takes for your company to convert investments in inventory to cash. This can help you understand exactly how long revenue gets tied up in production/sales before it’s converted to cash. If your company's cash conversion cycle is on the low end, it means that your business has a fast inventory-to-sales pipeline. If it is on the higher end, your company has a slow inventory-to-sales conversion. Your CCC can also be negative which means that your company requires less time to sell and convert to cash than it to pay suppliers. It is also helpful to note that CCC is most useful for larger retails buying and managing inventory and less useful for eg software companies.
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How to calculate CCC
The cash conversion cycle formula is as follows: Cash Conversion Cycle = DIO + DSO – DPO
DIO = Days Inventory Outstanding/ DSO = Days Sales Outstanding/ DPO = Days Payable Outstanding
DIO and DSO are cash incoming and DSO is cash outcoming, hence the latter is a negative figure.
How to calculate the individual elements
- DIO describes the average number of days it takes your business to convert inventory to sales. The formula is as follows: DIO = Average Inventory / Cost of Goods Sold x 365
- DSO describes the number of days that a business takes to collect its receivables. The formula is as follows: DSO = Average Accounts Receivable / Total Credit Sales x 365
- DPO defines how many days it takes your business to pay back invoices from suppliers. The formula is as follows: DPO = Average Accounts Payable / Cost of Goods Sold x 365
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Example
Company X sells cat food. They have a DIO of 18 days, a DSO of 35 days, and a DPO of 55 days. This is how you would calculate the their CCC: CCC = 18 + 45 – 55 = 8. Company X's CCC is 7, which means they convert inventory to cash efficiently.
Understanding the cash conversion cycle calculation
Calculating your business's CCC will help you understand how efficiently your business manages its working capital.
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You can improve your CCC by keeping an eye on inventory management, sales, and payables.