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Cash Conversion Cycle [Video]

Cash Conversion Cycle

The cash conversion cycle (or cash-to-cash cycle) is the length of time between (1) when a company pays cash for its inventory and (2) when it receives cash from its customers.

The cash conversion cycle is the sum of (a) the number of days it takes to sell inventory and (b) the number of days it takes to collect receivables MINUS (c) the number of days it takes to pay the company’s suppliers

CCC = Days to Sell Inventory + Days Sales Outstanding – Days Payable Outstanding

The cash conversion cycle is important because it tells you how long the company needs to finance its inventory. And the longer the cash conversion cycle, the more financing the company will need.

For example, let’s say a company purchases inventory from a supplier today. The supplier says the company can pay for the inventory in 25 days.

But the company doesn’t sell the inventory for 40 days. And once the inventory is sold, it takes another 30 days to collect cash from the customer. Thus, when it’s time to pay the supplier for the inventory (25 days) the company is still 45 days away from receiving cash for the inventory (30 + 40 – 25). The company needs to pay for the inventory on day 25 but doesn’t receive cash for the inventory until day 70.

That 45-day period of time is the cash conversion cycle.
The company will need to borrow money or come up with some other form of financing to bridge the gap until it receives cash from customers .
A long cash conversion cycle can lead to costly finance charges, so companies can save a lot of money by shortening the cycle.
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