Treasury Today Country Profiles in association with Citi

Cash Conversion Cycle

The cash conversion cycle (CCC) is the average time in days that it takes a company to convert the spending of cash for raw materials and other supplies into the receipt of cash through the sale of products or services to customers. It is a fundamental measure of working capital and supply chain management.

A shorter cash conversion cycle means that less cash is tied up in working capital and thus less funding (borrowing) is needed or there is more cash available for other purposes. Conversely the longer the cash conversion cycle, the longer cash is tied up (or invested) in raw material, work-in-progress and finshed stock and is unavailable for other purposes, such as investing.

The CCC can be divided into three individual measures. The first stage measures the period from which supplies are paid for up to the point at which the finished goods are sold; the second stage measures the period needed for collecting proceeds after a sale has been made and the third stage measures how long the company takes on average to pay its bills.

Using these measures the cash conversion cycle is calculated as follows:

CCC = Days inventory outstanding (DIO) + Days sales outstanding (DSO) Days payable outstanding (DPO)

Days inventory outstanding (DIO), also known as days sales of inventory (DSI), measures in days how long it takes a company to turn raw material, inventory and goods that are in production into sales. This average ‘stockholding period’ can be calculated by dividing the inventory by the cost of sales for a period and multiplying by the number of days in that period. It is a measure of how many times the stock has turned over in the period. Normally the measure is for a year but businesses subject to seasonal peaks and troughs may find shorter measures are more informative as they will measure whether the amount of cash tied up in working capital varies during the year as the cycle lengthens or shortens.

The second stage of the cash conversion cycle calculates how long in days a company needs on average to collect the sales proceeds once a sale has taken place. This assumes some or all sales are on credit terms. The faster cash is collected and therefore the lower the days sales outstanding (DSO) figure, the sooner cash can be reinvested in the company and the need for credit is reduced. However, like DIO, the DSO figure varies depending on the industry. A high DSO usually indicates that goods are sold to customers on extended credit, but it could also mean that a company is not effective in collecting its receivables. DSO is calculated by dividing the accounts receivable by the total credit sales in a period multiplied by the number of days in the period. Once again a year is the normal basis for the measure, so 365 would be the number of days.

The final stage of the CCC measures how much time a company takes to pay its trade creditors – in other words, how much credit it takes from its suppliers. Over a year this can be calculated by dividing the accounts payable by the cost of sales multiplied by 365 days.

The normal cash conversion cycle formula is therefore:

CCC = Inventory Cost of sales × 365 + Accounts receivable Total credit sales × 365 Accounts payable Cost of sales × 365

The CCC measures the time period from the outlay of cash for stock to the recovery of cash after the sale. Typically a company will purchase raw materials and other stock on credit and also sell its goods on credit. However, there are companies that have a different business model. If a company purchases on credit but sells for cash (for example in retail), this can even lead to a negative cash conversion cycle. The same might apply when goods are produced using just-in-time supplies and the customer pays upfront.