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The Cash Conversion Cycle (Speed Matters)

We are aware of what traps our cash. But how do we determine our efficiency in getting it back? Welcome to the CCC (Cash Conversion Cycle). Speed is everything in business. Let us examine how quickly you are capable of transforming one dollar of inventory into one dollar cash.

The Cash Conversion Cycle (CCC) is a measure of the number of days it takes for a company to convert its investments in inventory and resources into cash flows from sales.

Consider it on a countdown. The timer starts when you pay your supplier for the raw goods and stops when your customer pays you for the finished goods.

The cycle consists of three different components:

  1. Days Inventory Outstanding: How many days is your product in your warehouse before a sale? (Faster is better).
  2. Days Sales Outstanding: Once sold, how many days does it take the customer to pay their invoice? (Faster is better).
  3. Days Payable Outstanding: How many days do you take to pay your suppliers? (Slower is better, as it keeps cash in your account longer).

The formula puts this all together:

\[ \text{CCC} = \text{Days Inventory} + \text{Days Sales} - \text{Days Payable} \]

Example:

  • It takes you 40 days to sell your inventory.
  • It takes your customers 30 days to pay you.
  • You pay your suppliers in 20 days.
\[ \text{CCC} = 40 + 30 - 20 = 50 \text{ days} \]

This means your funds will be frozen for a period of 50 days. For those 50 days, you'll have to find other ways to pay employees and the rent (generally from cash you've saved or borrowed from a bank). The healthier your company, the lower your CCC. Some massive companies, like Amazon, even have a negative cash conversion cycle it means they get paid by customers long before having to pay their suppliers!

You have mastered the cash flow! You realize profit is nothing but just an accrual concept and that handling inventory, receivables, and payables speedily is the only way you can keep a business afloat. Chapter 3 uses this data to analyses performance by ratios. It is time for your last exercises!

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