In this article, we outline how to calculate the cash conversion cycle (CCC), identifying the three key components and what a short and long CCC means for your business.
Managing cash flow is very important to gauge the financial health of any business. So, how can a business measure the success of their cash flow management? The Cash Conversion Cycle, also known as CCC, looks at how fast a company changes its investments in inventory and other resources into cash flows from sales.
3 Key Components of the Cash Conversion Cycle
Within the CCC are three key components:
- Days Inventory Outstanding (DIO): Measures the average number of days for a company to sell its inventory. It is calculated by dividing the average inventory with cost of goods sold, then multiplied by 365 days.
- Days Sales Outstanding (DSO): Measures the average number of days for a company to collect payment after a sale. It is calculated by dividing accounts receivable by total credit sales, then multiplied by 365 days.
- Days Payable Outstanding (DPO): Measures the average number of days for a company to pay its suppliers. It is calculated by dividing accounts payable by cost of goods sold, then multiplied by 365 days.
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How To Calculate The Cash Conversion Cycle
After these three numbers are calculated, the CCC is determined as below:
CCC = DIO + DSO – DPO
Usually, a shorter CCC means your business can turn investments into cash and improve overall liquidity. On the other hand, a longer CCC can mean that there are gaps within inventory management, receivables collection, or supplier payment.
How To Improve Your Cash Conversion Cycle
To improve your CCC, consider the following:
- Optimise Inventory Management: Reduce excess stock to improve turnover rates.
- Speed Up Receivables: Implement strict credit policies and use automated invoicing to collect payments faster.
- Extend Payables: Negotiate longer payment terms with suppliers without harming relationships.
Related Article: Mastering The Cash Conversion Cycle: Tips For Managing Accounts Receivable.
Conclusion
Finally, understanding how to calculate the Cash Conversion Cycle can help to maintain a positive cash flow and ensure that your financial operations run smoothly. Breaking down the calculations into DIO, DSO, and DPO can also offer greater insight into which areas to improve.
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About B2BE
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