Cash Conversion Cycle Guide: How to Calculate CCC

The cash conversion cycle (CCC) is a ratio that measures how long it takes for a company to sell inventory and turn initial capital investment into cash. CCC, also known simply as the Cash Cycle or Net Operating Cycle, is measured in days, representing the length of time it takes for a business's inventory to move through the sales and distribution process and for accounts receivable to become liquid capital.

Only businesses that stock inventory (like retail stores, e-commerce retailers, and car dealerships) can use the CCC metric. This is because this calculation specifically focuses on how efficient a business’ operations are at processing and selling inventory. A lower CCC means a company is more efficient at inventory turnover. A company with a negative cash conversion cycle, or negative CCC, reflected in their financial statements and balance sheets show that a company's working capital converts back to cash very quickly.

The cash conversion cycle calculation takes a series of operational and accounting variables into consideration. Many of these variables can be found in a company’s financial statements, like a balance sheet or an income statement. Here are the five elements that a business needs to consider when calculating the cash conversion cycle for a business.

1. 1. Revenue and Cost of Goods Sold (COGS): Calculating the CCC requires the revenue earned on the sale of goods and the cost of producing those goods, both of which found on a business's income statement.
2. 2. Inventory: The amount of inventory at the beginning and the end of the CCC period is required when you’re calculating the cash conversion cycle. This is typically represented in DIO (or days inventory outstanding), a metric that represents how quickly a company offloads its inventory.
3. 3. Accounts receivable: The amount of money owed to the business to pay off the sale of goods and inventory at the beginning and the end of the CCC period. This is represented by average DSO (or days sales outstanding) for the time period, which represents how quickly a company collects outstanding payments from debtors.
4. 4. Accounts payable: The amount of money a business owes to retailers or suppliers related to the production of goods at the beginning and the end of the CCC period. This is accounted for as DPO (or days payable outstanding), which is a ratio that approximates the number of days a company takes to pay off items in its accounts payable period.
5. 5. Time: You should account for the number of days in the period that you’re measuring your CCC.

The cash conversion cycle formula is calculated using the following equation
CCC (cash conversion cycle) = DIO (Days Inventory Outstanding) + DSO (Days Sales Outstanding) - DPO (Days Payable Outstanding). To calculate each of those figures, use the following equations.

• Days of Inventory Outstanding: DIO is calculated by dividing the average inventory by the cost of goods sold (COGS), then multiplying that number of days in the CCC cycle. Average inventory is calculated by adding beginning inventory and ending inventory of the CCC period, then dividing that number by 2.
• Days of Sales Outstanding: DSO is calculated by dividing the average accounts receivable by revenue per day. Average accounts receivable is calculated by adding the accounts receivable at the beginning and the end of the CCC period, then dividing that number by 2.
• Days of Payable Outstanding: DPO is calculated by dividing the average accounts payable by the cost of goods sold (COGS). Average accounts payable is calculated by adding the accounts payable from the beginning and the end of the CCC period, then dividing that number by 2.

A company's cash conversion cycle is important for tracking the average number of days it takes for a company to turn initial investment into cash returns. This helps a company understand how efficient its operations are and which stages in the process are the least efficient in bringing in cash flow.

A low CCC means that a company’s inventory chain is running efficiently, while a high number can indicate that there are financial or inventory management issues. Understanding CCC is helpful for a business to isolate where in their operations cash flow is impeded, by inventory mismanagement, excessive payables, or problems with sales.

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