Cash Conversion Cycle

The cash conversion cycle is a cash flow calculation that attempts to measure the time it
takes a company to convert its investment in inventory and other resource inputs into cash.
In other words, the cash conversion cycle calculation measures how long cash is tied up in
inventory before the inventory is sold and cash is collected from customers.
The cash cycle has three distinct parts. The first part of the cycle represents the current
inventory level and how long it will take the company to sell this inventory. This stage is
calculated by using the days inventory outstanding calculation.
The second stage of the cash cycle represents the current sales and the amount of time it
takes to collect the cash from these sales. This is calculated by using the days sales
outstanding calculation.
The third stage represents the current outstanding payables. In other words, this represents
how much a company owes its current vendors for inventory and goods purchases and
when the company will have to pay off its vendors. This is calculated by using the days
payables outstanding calculation.

Formula
The cash conversion cycle is calculated by adding the days inventory outstanding to the
days sales outstanding and subtracting the days payable outstanding.

All three of these smaller calculations will have to be made before the CCC can be
calculated.

Analysis
The cash conversion cycle measures how many days it takes a company to receive cash
from a customer from its initial cash outlay for inventory. For example, a typical retailer buys
inventory on credit from its vendors. When the inventory is purchased, a payable is
established, but cash isn't actually paid for some time.
The payable is paid within 30 days and the inventory is marketed to customers and
eventually sold to a customer on account. The customer then pays for the inventory within
30 days of purchasing it.
The cash cycle measures the amount of days between paying the vendor for the inventory
and when the retailer actually receives the cash from the customer.
As with most cash flow calculations, smaller or shorter calculations are almost always good.
A small conversion cycle means that a company's money is tied up in inventory for less
time. In other words, a company with a small conversion cycle can buy inventory, sell it, and
receive cash from customers in less time.
In this way, the cash conversion cycle can be viewed as a sales efficiency calculation. It
shows how quickly and efficiently a company can buy, sell, and collect on its inventory.

Example
Tim's Tackle is a retailer that sells outdoor and fishing equipment. Tim buys its inventory
from one main vendor and pays its accounts within 10 days in order to get a purchase
discount. Tim has a fairly high inventory turnover ratio for his industry and can collect
accounts receivable from his customer within 30 days on average.
Tim's days calculations are as follows:

DIO represents days inventory outstanding: 15 days

DSO represents days sales outstanding: 2 days
DPO represents days payable outstanding: 12 days

Tim's conversion cycle is calculated like this:

As you can see, Tim's cash conversion cycle is 5 days. This means it takes Tim 5 days from
paying for his inventory to receive the cash from its sale. Tim would have to compare his
cycle to other companies in his industry over time to see if his cycle is reasonable or needs
to be improved.

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ash Conversion Cycle - CCC

AAA |

DEFINITION of 'Cash Conversion Cycle - CCC'

The cash conversion cycle (CCC) is a metric that expresses the length of time, in
days, that it takes for a company to convert resource inputs into cash flows. The

cash conversion cycle attempts to measure the amount of time each net input
dollar is tied up in the production and sales process before it is converted into
cash through sales to customers. This metric looks at the amount of time needed
to sell inventory, the amount of time needed to collect receivables and the length
of time the company is afforded to pay its bills without incurring penalties.
The CCC is also referred to as the "cash cycle."
The metric is calculated as:

Where: DIO represents days inventory outstanding, DSO represents days sales
outstanding and DPO represents days payable outstanding

Next Up
1.
2.
4.

WORKING CAPITAL
CAPITAL FUNDING
3.
INVENTORY
ACCOUNTS RECEIVABLE - AR

5.

VIDEO
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BREAKING DOWN 'Cash Conversion Cycle - CCC'

Usually a company acquires inventory on credit, which results in accounts

payable. A company can also sell products on credit, which results in accounts
receivable. Cash, therefore, is not involved until the company pays the accounts
payable and collects the accounts receivable. So the cash conversion cycle
measures the time between the outlay of cash and the cash recovery. The CCC
cannot be observed directly in cash flows, which are affected by financing and
investment activities as well; rather, the cycle refers to the time span between a
firm's disbursing and collecting cash.

The Calculation
The calculation of CCC involves several items from financial statements for a
certain period of time (generally 365 days for a year or 90 days for a quarter).
The formula for calculating CCC is as follows:
CCC = DIO + DSO - DPO
Days Inventory Outstanding (DIO) refers to the number of days it takes to sell an
entire inventory. A smaller DIO is preferred. Days Sales Outstanding (DSO) refers
to the number of days needed to collect on sales, or accounts receivable. A
smaller DSO is also preferred. Days Payable Outstanding (DPO) refers to the
company's payment of its own bills, or accounts payable. By maximizing this
number, the company holds onto cash longer, increasing its investment potential.
Thus, a longer DPO is preferred.
For more information on the cash conversion cycle and its corresponding formula,
see Understanding the Cash Conversion Cycle.

What It Means
The cash conversion cycle is a metric used to gauge the effectiveness of a
company's management and, consequently, the overall health of that company.
The calculation measures how fast a company can convert cash on hand into
inventory and accounts payable, through sales and accounts receivable, and
then back into cash. By combining these activity ratios, the measurement

indicates the efficiency of the management's ability to employ short-term

assets and liabilities to generate cash for the company. The CCC entails
the liquidity risk associated with growth by measuring the length of time that a
firm will be deprived of cash if it increases its investment in resources in an effort
to elevate sales. It can be especially useful for investors who wish to draw a
comparison between close competitors, as a low CCC signifies a well-managed
company, and thus can be used to help evaluate potential investments. The CCC
should be combined with other metrics, such as the return on equity and return
on assets, as an indicator of management effectiveness and company viability.
While the term applies to companies in any industry, the cycle is extremely
important for retailers and similar businesses, as their operations consist of
buying inventories and selling them to customers. The metric does not apply to
companies for which this is not the case, such as those in the software or
insurance industries. The measure illustrates how quickly a company can convert
its products into cash through sales. The shorter the cycle, the less time capital is
tied up in the business process, and thus the better for the company's bottom
line.
An important distinction is that the cycle applies to firms that buy and sell on
account, while cash-only firms only accommodate data from sales operations in
the equation, as their disbursed cash is directly measurable as purchase of
inventory, and their collected cash is measurable as sale of inventory. This direct
ratio does not exist for firms that buy and sell on account. Changes in inventory
occasion payables and receivables rather than cash flows, and increases and
decreases in cash will discount these accounting vehicles from statements.
Therefore, the CCC is calculated according to the cycle of cash through
receivables, inventory, payables and, eventually, back to cash.

Why It Matters
The CCC measurement on its own does not carry much meaning. It should
generally be used to track a company over several consecutive time periods and
compared to multiple competitors. By tracking the CCC over time, patterns of
bettering or worsening value can be more telling than a single period's CCC value

taken out of context. Similarly, comparing the CCC from one period to that of a
competitor or multiple competitors can elucidate which company is succeeding
inand which is failing atmoving inventory, collecting payments and keeping
cash on hand.
Based off of CCC reports, analysis of cash flow statements and liquidity position,
companies can adjust their standard of credit purchase payments or cash
collections from debtors. A company's investment decisions can directly influence
its CCC. In times of cheap credit, cash cycles have been slow to shorten, as it
becomes more affordable for companies to borrow money toward their inventory
investments. In fact, cheap debt has led large retailers and other similar
companies to increase their debt loads by more than 60% since 2007 and,
according to the Wall Street Journal, "By taking on more debt, companies can
invest in operations, and fund dividends and buybacks, without having to
generate cash any faster," leading to stagnant CCCs across the board.
One exception to this trend, interestingly, is the cash cycle of online retailers.
Frequently, because online retailers can pay their suppliers for goods after they
receive payment for those goods from customers, they don't need to hold as
much inventory in house. And since they are still able to hold onto that cash for a
longer period of time, they often actually wind up with a negative CCC.
Amazon.com Inc. (AMZN) is a perfect example of this, wildly outperforming its
retail competitors, such as Wal-Mart Stores Inc. (WMT), Target Corp. (TGT) and
CostCo Wholesale Corporation (COST), in terms of the length of its cash cycle, if
not overall revenue.
According to a Forbes calculation of a period running through 2012, Amazon
"manages to hold inventory for 28.9 days plus 10.6 days to collect receivables or
40 days in total but then pays accounts payable in 54 days thus achieving a
negative cash conversion cycle for Amazon.com of -14 days. You dont see this
that often but definitely a win for Amazon shareholders. Maybe not for the
suppliers waiting for their checks." While online retailers generally have this
advantage over their brick-and-mortar counterparts, it is important to note that
CCC should not be taken out of context, and should be used in conjunction with
other metrics.

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Understanding The Cash

Conversion Cycle
By Jim Mueller | Updated October 08, 2015AAA |
http://w w w

00:02
01:47

The cash conversion cycle (CCC) is one of several measures of management

effectiveness. It measures how fast a company can convert cash on hand into
even more cash on hand. The CCC does this by following the cash as it is first
converted into inventory and accounts payable (AP), through sales and accounts
receivable (AR), and then back into cash. Generally, the lower this number is, the
better for the company. Although it should be combined with other metrics (such
as return on equity andreturn on assets), it can be especially useful for
comparing close competitors, because the company with the lowest CCC is often
the one with better management. In this article, we'll explain how CCC works and
show you how to use it to evaluate potential investments.
What Is It?
The CCC is a combination of several activity ratios involving accounts receivable,
accounts payable and inventory turnover. AR and inventory are short-term
assets, while AP is a liability; all of these ratios are found on the balance sheet. In
essence, the ratios indicate how efficiently management is using short-term
assets and liabilities to generate cash. This allows an investor to gauge the
company's overall health.
How do these ratios relate to business? If the company sells what people want to
buy, cash cycles through the business quickly. If management cannot figure out
what sells, the CCC slows down. For instance, if too much inventory builds up,
cash is tied up in goods that cannot be sold - this is not good news for the
company. To move out this inventory quickly, management might have to slash
prices, possibly selling its product at a loss. If AR is handled poorly, it means that
the company is having difficulty collecting payment from customers. This is
because AR is essentially a loan to the customer, so the company loses out
whenever customers delay payment. The longer a company has to wait to be
paid, the longer that money is unavailable for investment elsewhere. On the other
hand, the company benefits by slowing down payment of AP to its suppliers,
because that allows it to make use of the money longer.

The Calculation
To calculate CCC, you need several items from the financial statements:
Revenue and cost of goods sold (COGS) from the income statement;
Inventory at the beginning and end of the time period;
AR at the beginning and end of the time period;
AP at the beginning and end of the time period; and
The number of days in the period (year = 365 days, quarter = 90).
Inventory, AR and AP are found on two different balance sheets. If the period is a
quarter, then use the balance sheets for the quarter in question and the ones
from the preceding period. For a yearly period, use the balance sheets for the
quarter (or year end) in question and the one from the same quarter a year
earlier.
This is because while the income statement covers everything that happened
over a certain time period, balance sheets are only snapshots of what the
company was like at a particular moment in time. For things like AP, you want an
average over the time period you are investigating, which means that AP from
both the time period's end and beginning are needed for the calculation.
Now that you have some background on what goes into calculating CCC, let's
look at the formula:
CCC = DIO + DSO - DPO
Let's look at each component and how it relates to the business activities
discussed above.
Days Inventory Outstanding (DIO): This addresses the question of how many
days it takes to sell the entire inventory. The smaller this number is, the better.
DIO = Average inventory/COGS per day

Average Inventory = (beginning inventory + ending inventory)/2

Days Sales Outstanding (DSO): This looks at the number of days needed to
collect on sales and involves AR. While cash-only sales have a DSO of zero,
people do use credit extended by the company, so this number will be positive.
Again, smaller is better.
DSO = Average AR / Revenue per day
Average AR = (beginning AR + ending AR)/2

Days Payable Outstanding (DPO): This involves the company's payment of its
own bills or AP. If this can be maximized, the company holds onto cash longer,
maximizing its investment potential; therefore, a longer DPO is better.
DPO = Average AP/COGS per day
Average AP = (beginning AP + ending AP)/2

Notice that DIO, DSO and DPO are all paired with the appropriate term from the
income statement, either revenue or COGS. Inventory and AP are paired with
COGS, while AR is paired with revenue.
Example
Let's use a fictional example to work through. The data below is from a fictional
retailer Company X's financial statements. All numbers are in millions of dollars.
Item

Fiscal Year 2013

Fiscal Year 2012

Revenue

9,000

Not needed

COGS

3,000

Not needed

Inventory

1,000

2,000

A/R

100

90

A/P

800

900

Average Inventory

(1,000 + 2,000) / 2 = 1,500

Average AR

(100 + 90) / 2 = 95

Average AP

(800 + 900) / 2 = 850

Now, using the above formulas, CCC is calculated:

DIO = $1,500 / ($3,000/ 365 days) = 182.5 days

DSO = $95 / ($9,000 / 365 days) = 3.9 days
DPO = $850 / ($3,000/ 365 days) = 103.4 days
CCC = 182.5 + 3.9 - 103.4 = 83 days

What Now?
As a stand-alone number, CCC doesn't mean very much. Instead, it should be
used to track a company over time and to compare the company to its
competitors.
When tracking over time, determine CCC over several years and look for an
improvement or worsening of the value. For instance, if for fiscal year 2012,
Company X's CCC was 90 days, then the company has shown an improvement
between the ends of fiscal year 2012 and fiscal year 2013. While between these
two years the change is good, a significant change in DIO, DSO or DPO might
merit more investigation, such as looking further back in time. CCC changes
should be examined over several years to get the best sense of how things are
changing.
CCC should also be calculated for the same time periods for the company's
competitors. For example, for fiscal year 2013, Company X's competitor
Company Y's CCC was 100.9 days (190 + 5 - 94.1). Compared to company Y,
company X is doing a better job at moving inventory (lower DIO), is quicker at
collecting what it is owed (lower DSO) and keeps its own money a bit longer
(higher DPO). Remember, however, that CCC should not be the only metric used
to evaluate either the company or the management; return on equity and return
on assets are also valuable tools for determining management's effectiveness.
To make things more interesting, assume Company X has an online retailer
competitor Company Z. Company Z's CCC for the same period is negative,
coming in at -31.2 days. This means that Company Z doesn't pay its suppliers for
the goods that it buys until after it receives payment for selling those goods.
Therefore, Company Z doesn't need to hold very much inventory and still holds
onto its money for a longer time period. Online retailers usually have this
advantage in terms of CCC, which is another reason why CCC should never be
used alone without other metrics.

The Bottom Line

The CCC is one of several tools that can help you evaluate management,
especially if it is calculated for several consecutive time periods and for several
competitors. Decreasing or steady CCCs are good, while rising ones should
motivate you to dig a bit deeper.
CCC is most effective with retail-type companies, which have inventories that are
sold to customers. Consulting businesses, software companies and insurance
companies are all examples of companies for whom this metric is meaningless.
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