Cash Conversion Cycle

what is the Cash Conversion Cycle?

The cash conversion cycle, also known as the asset conversion cycle, is an expression of time, in days, that it takes to purchase raw materials for production, convert them into goods, sell them, and collect the accounts receivable for those sales. 

It is a very important management efficiency ratio; generally speaking, a shorter CCC is an indication of high levels of liquidity while a higher CCC may indicate the firms inability to manage the process of the production or even issues with qualifying borrowers accurately.  In some cases, it is possible for for the CCC to be negative and this could indicate a problem with the companies ability to repay its creditors and this needs to be taken very seriuosly. 

It is important to look at any number on the financial statement in the proper context.  Different industries will have different normal ranges.  It is important to look at the trend over time and equally important to look at each component of the formula on its own.

The cash conversion cycle is very heavily scrutinized by investors for small cap companies who are typically new start-ups or have been experiencing very explosive growth.  These are the companies which are most prone to having cash flow issues during a time of economic slowdown. 

Cash Conversion Cycle Calculation

To calculate the cash conversion cycle, you can use the following formula:
Cash Conversion Cycle

The formula above is pretty straight forward.  Accounts receivables turnover represents the amount of time it takes to collect sales dollars from customers.  Inventory turnover describes the number of days needed to turn raw materials into goods and sell them.  Finally, accounts payable turnover represents the number of days that it takes a business to repay its creditors for raw material acquisitions and other resource inputs.  As you can see, the formula takes into account the number of days to acquire, produce, sell, and collect funds.

Flow of Funds in the Cash Conversion Cycle
Tim Ord
Ord Oracle

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