The CCC is a business metric that indicates how many days it would take for an organization to convert its goods to cash. Also referred to as the cash cycle or net operating cycle, this metric is designed to illustrate the overall operating efficiency. The cash conversion cycle factors in the average time it takes for a company to sell its entire inventory, how long it takes to collect cash from customers, and how long they have to pay off its bills. Ultimately, this metric allows an organization to assess its inefficiencies within management and operations so it can make the required adjustments to improve organizational performance.
It is important to note that the CCC should be used in combination with other ratios, such as ROE (return on equity) and ROA (return on assets), and also compared with competitors. These benchmarks will allow you to gain a more accurate understanding of your company’s current standing. By keeping a close eye on this metric, you will be able to spot inefficiencies within processes that reduce free cash flows and potential liquidity.
How is the cash conversion cycle calculated?
There are three unique components that are involved in the CCC calculation. The three working capital metrics that can be calculated from the balance sheet and income statement include the days inventory outstanding, days sales outstanding, and the days payable outstanding.
Days Inventory Outstanding: Total amount of inventory held at the end of the previous period/Total amount of inventory sold during the previous period.
Days Sales Outstanding: Total amount collected from customers minus the total amount paid out to suppliers.
Days Payable Outstanding: Amount owed to creditors less amount received from customers.
Cash conversion cycle formula
It is important to understand that these numbers are not static; rather, they fluctuate throughout the year based on seasonal fluctuations and changes in demand. This means that the number of days each component takes to turn into cash varies depending on the season and the demand level. For example, if there was a spike in demand during the holiday shopping season, then the days payable outstanding could increase by several weeks. In addition, the days sales outstanding could decrease because businesses tend to hold back their cash until they receive payment from their customers.
How to interpret cash conversion cycle
Generally speaking, companies with a lower CCC tend to have a stronger cash management strategy in place. A downward-trending CCC may indicate that efficiencies in the business model are improving, especially if previous periods are higher. In contrast, a higher CCC means that the actual cash flow of a company is straying away from what is on the income statement. A high CCC is also an indicator that an organization’s cash is tied up in its operations, like if they aren’t turning inventory quickly enough or if inventory has been in storage facilities for an extended period of time before it is sold.
