The cash conversion cycle(CCC), also known as the net operating cycle or cash cycle, measures the time a company takes to encash its inventory. The cash cycle estimates the time a company takes to convert each net input dollar used for the production and sale of products into cash received in their bank account.
The cash conversion cycle (CCC) is a working capital metric that measures the number of days a company needs to convert its inventory investment into cash via the sales process. A shorter CCC is considered ‘good’ as it denotes that the company has less cash tied up in its accounts receivable and inventory, whereas a longer CCC means that the company takes more time to generate cash.
CCC helps estimate the operational efficiency and financial performance of a company. Therefore, calculating the cash cycle is essential for companies that wish to track their cash flow, sales realization, and inventory management.
The cash conversion cycle covers three stages of a company’s sales cycle—current inventory sales, cash collection from the current sales, and payables for outsourced goods and services.
The CCC can be calculated with the help of three working capital metrics. These are:
DIO and DSO are short-term assets that can be held for a year or less, whereas DPO is classified as a liability.
Let’s assume that a company’s DIO is 50 days, DSO is 70 days, and DPO is 85 days. The cash conversion cycle can be calculated as follows:
CCC= 50+70-85 = 35
Therefore, the cash conversion cycle of the company is 35 days.
The cash conversion cycle is an important metric when it comes to a company’s manufacturing operations as it helps manage the inventory. If not managed well, a company will either be short on supply or have too much of it, increasing storage costs. Apart from the inventory management and cash flow efficiencies, CCC also assists finance leaders in:
The key stakeholders of a company often assess the cash conversion cycle to examine its financial health, and more importantly the company’s liquidity. It determines how fast the company can pay back a business loan, and meet other financial obligations for its growth.
Vendors often look at your cash conversion cycle while deciding whether or not to give your company trade credit. If your company has maintained a low CCC, it means that your company has enough liquidity and this improves the chances of getting better credit terms.
Lower cash conversion cycle improves your chances of getting business loans. Low CCC indicates healthy liquidity, which means you can comfortably pay back your loans. This adds a sense of security and increases the chances of loan approvals.
A simple way to understand the trajectory of a cash conversion cycle is using graphical interpretation—the downward and upward movement. If the CCC is in a declining trend, it denotes a positive sign, and if you observe an upward trend, it means potential inefficiencies in your order-to-cash processes.
The cash conversion cycle measures the number of days it takes for inventory to get converted into cash. But, do you want to know how you can shorten your CCC? Here’re some tips:
Managing payables such as supplier payment terms is the key to controlling working capital. You can see positive trends in your CCC if you leverage and consolidate your spending by increasing supplier collaboration and extending payment terms.
As a business owner, you can perform other activities such as negotiating the time required to pay the suppliers. But you have to be cautious that it doesn’t harm or put the supply chain at risk. Delaying payments can also be reckless when trying to develop a strong relationship with the supplier.
One of the major concerns of reducing inventory size is the impact it could have on customer retention. Poor inventory management could also lead to lower sales due to the inability to service the placed orders. Thus, inventory management should be prioritized alongside sales, profit, and payment data of the customers.
The development of new relationships with customers and clients can also improve inventory management. It could lead to more accurate sales forecasts of the top-selling products and better decisions on the number of raw materials or inventory required.
First and foremost, you need to understand the reasons why your customers are delaying payments of the claimed invoices. Then, you need to provide them with a plan that could resolve their problems with regard to underlying invoices and disputes.
Another way of reducing the risk of overdue invoices is by categorizing and prioritizing the customers by size and risk profile.
Taking the necessary steps to shorten the cash conversion cycle helps improve a business’s cash flow. CCC calculation can help you improve your inventory management, credit sales, and purchase management strategies. It also enables you to track your liquidity. Investors can use CCC data to compare different companies in the same industry to assess cash flow management.
Automating the processes involved in setting customer credit limits, inventory tracking, and collections can help you reduce manual efforts and errors, and shorten the cash cycle. Our solutions help streamline the order-to-cash process using AI and RPA technology. Visit our product page to know more about our solutions.
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Answer: The cash conversion cycle (CCC) ratio is the metric that defines the number of days a company takes to convert the money invested in the inventory to cash.
Answer: A negative cash conversion cycle means that the inventory is sold out before you have to pay for it.
Answer: A positive cash conversion cycle defines the number of days your company’s working capital is involved in the inventory while the accounts are settled. If you have a high CCC, then it denotes that your customers take almost 30, 60, or 90 days to settle your account.
Answer: If your cash conversion cycle is shorter than the industry average, then it is said to be good. The lower the CCC, the better it is. A lower number means that your working capital is not tied up for a longer period of time and your business has greater liquidity in terms of cash flow.
Answer: The three components of the cash conversion cycle are: Days inventory outstanding (DIO), Days sales outstanding (DSO), and Days payable outstanding (DPO).
Answer: The operating cycle measures the days a company takes to convert its inventory into cash. Whereas, the cash conversion cycle measures what a business does not have to pay back its suppliers.
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