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.
