Cash Conversation Cycle

Breaking down the Cash Conversion Cycle.

Cash Conversion Cycle:
A company’s cash conversion cycle (CCC) is an important business metric, which shows the efficiency of the company’s daily operations. Keeping track of it allows businesses to gain an understanding of how quickly cash can be converted into sales and returned to cash. Furthermore, it facilitates the creation of a clear picture of the cash flow position of the business. Companies that are engaged in manufacturing or retail must manage physical inventory in order to maximize their profitability. One of the main aims of cash management is to run the company with as little cash as possible tied up in inventory or accounts receivable – this can be managed and understood through the Cash Conversion Cycle.

What is the cash conversion cycle?

The cash conversion cycle (CCC) is a figure that demonstrates the average amount of time (in days) it takes to see cash after your business makes an inventory purchase. The calculation takes into account your cash flow, this is done over a one-year period. The cash conversion cycle is an invaluable metric for business owners to track their business, inventory and more information regarding their business. Understanding your CCC allows you to fully understand the way cash flows through your business. Thus, your business will be able to formulate a budget or restructure its financial strategy.

Calculating the Cash Conversion Cycle

There are three metrics you need to calculate the cash conversion cycle:

  • Days Inventory Outstanding (DIO)
  • Days Sales Outstanding (DSO)
  • Days Payable Outstanding (DPO).

To obtain these metrics, you will need to have your financial statements prepared, such as; balance sheets and income statements.

What is a Good Cash Conversion Cycle?

Lower Cash Conversion Cycle – The lower the cash conversion cycle, the faster inventory turns into sales for the company.

Higher Cash Conversion Cycle – Having a higher cash conversion cycle may result in your business converting inventory to cash at a much slower rate.

Cash Conversion Cycles with lower values are perceived to be better. This is because they indicate that the business has the ability to convert cash on hand into cash from sales in a more timely manner.

The presence of higher values may be indicative of inefficient cash management on the part of the company. It is possible for this value to increase for a variety of reasons, including settling accounts payable too early, waiting too long to collect receivables, or having a low inventory turnover ratio.

When your business has a negative CCC, it means you have a longer period of duration for your company to pay creditors (such as invoices and suppliers) than it does for your company to receive payments from customers. In practice, this means that your suppliers are technically financing your business operations. As a result, you do not require additional capital to grow or expand your business.

On the other hand, a positive CCC reflects the fact that your business needs to have more cash on hand in order to cover expenses and grow. In this scenario, timely receipts and payments should be a priority.

The Cash Conversion Cycle Formula: What can we learn from it?

An overview of the cash conversion cycle can be described as follows: The CCC is a number that helps you identify how much cash your business needs to grow.

It may now be time for you to ask if you have a high number, “how can I reduce my CCC number?”

To reduce your CCC number you’ll need to:

  • You should reduce the quantity of inventory you hold at any given point in time
  • You can reduce your accounts receivable by ensuring your customers pay you quicker by better managing your invoices
  • Negotiate longer payment terms with suppliers in order to increase accounts payable.

The cash conversion cycle formula is a tool that shows you how quickly you can convert assets into cash.

The prolonged conversion cycle of cash can result in bankruptcy for small businesses. There is a risk of your business being unable to pay its bills each month if your cash outflow is greater than your cash inflow.

The cash conversion cycle is one of several metrics that will help you to understand and manage your assets in this regard.

Nevertheless, it does not provide a complete picture. In order for a business to improve its cash flow, steps should be taken to reduce the cash conversion cycle. Your inventory management strategy, credit sales strategy, and purchase management strategy can be improved by using the CCC calculation. Furthermore, it allows you to keep track of your liquidity. The CCC can be used by investors in order to compare the cash flow management of companies within the same industry. 

If you are looking to better understand Cash Conversion Cycle, reach out to Cash Flow Mike where we will be happy to help and provide you with bespoke tailored training to help you fill this important void.

P.S. Whenever you’re ready… here are 4 ways Mike can help you improve Cash Flow in your business.

  1. Grab a free copy of my book:

In The 7 Minute Conversation, you’ll learn how to analyze any company’s financial statements in 7 minutes or less. It includes a super valuable lesson on controlling expenses. — Download Here.

  • Join the Clear Path To Cash – Mining Your Business For Hidden Cash Facebook Community:

This is our new Facebook community where business owners who are using the concepts taught in The Clear Path To Cash can share lessons learned and receive advice from my team and other members of the community. — Join Our Facebook Group.

  • Participate in a Live Virtual Clear Path To Cash Seminar:

There are some people who prefer to learn concepts through self-study through books or video series.  For others, such as myself, it is necessary to be in a classroom environment and to be guided through the concept.  We offer a Virtual Seminar each month.  It takes only three hours each day for two days, during which you will learn about The Clear Path to Cash Program’s eight steps. 

I am so passionate about this one that I teach it myself. — Virtual Seminar.

  • Work with me and my team privately:

If you’d like to go over something outside of a group setting, no problem.  All you have to do is click this link to schedule a 15-minute Triage Call. In 15 minutes, we see if my team can help you with your problem.  Sometimes we can give you some advice on the spot, other times we will invite you to a longer Burning Issues call, where we dig into the issue a little deeper and give you some great advice.  Even if we don’t believe our program is a good fit for you, we try to connect you with the right professional from our network of friends. —  Schedule Your Triage Call.

author avatar
Marc Goodman