What is a Cash Conversion Cycle?

Cash Conversion Cycle Formula

The cash conversion cycle is calculated using the following formula:

• Days Inventory Outstanding (DIO) measures how long it takes to sell inventory.
• Days Sales Outstanding (DSO) tracks how long it takes to collect cash from customers.
• Days Payables Outstanding (DPO) measures how long a company takes to pay its suppliers.

The cash conversion cycle formula is as follows:

CCC = DIO + DSO – DPO

Example of the Cash Conversion Cycle Formula in Action

Let’s say a company has the following metrics:

• DIO: 45 days
• DSO: 30 days
• DPO: 25 days

Using the formula: 

CCC = DIO + DSO – DPO
CCC = 45 + 30 – 25 = 50 days

This means the company takes 50 days to convert its investment in inventory and receivables into cash. A shorter CCC would indicate the company is moving cash through its system more efficiently.

What Does a High Cash Conversion Cycle Mean?

A high cash conversion cycle indicates that a company takes longer to convert inventory and receivables into cash. This could suggest operational inefficiencies, poor cash management, or slow-paying customers. 

It may also mean that the company has excess inventory or is struggling to collect payments. 

While a high CCC can sometimes be a result of strategic decisions, it generally signals a need for improved working capital management.

What's important here?

The cash conversion cycle is a key indicator of a company's operational efficiency and liquidity. A low CCC suggests the company quickly turns its investments into cash, whereas a high CCC may highlight inefficiencies or cash flow issues. 

Monitoring and optimizing the CCC can lead to better cash management, reduced reliance on external financing, and stronger financial health.