What is the Cash Conversion Cycle (CCC)?
– The cash conversion cycle (CCC) is a short-term operating metric that measures how many days a company’s cash is tied up in the business cycle: buying or making inventory, selling it (often on credit), and finally collecting cash from customers while paying suppliers. A smaller CCC means cash moves back into the business more quickly. CCC is most meaningful for companies that hold and sell physical inventory; it’s less useful for pure-service or software firms.
Core formula and component definitions
– CCC = DIO + DSO − DPO
– DIO (Days Inventory Outstanding): average number of days inventory sits before being sold.
– Typical formula: DIO = (Average Inventory / Cost of Goods Sold) × Days in period
– DSO (Days Sales Outstanding): average number of days to collect cash after a sale.
– Typical formula: DSO = (Average Accounts Receivable / Revenue) × Days in period
– DPO (Days Payables Outstanding): average number of days the firm takes to pay its suppliers.
– Typical formula: DPO = (Average Accounts Payable / Cost of Goods Sold) × Days in period
– Notes on the denominators: DIO and DPO commonly use COGS because inventory and supplier payables relate to product cost. DSO uses sales (revenue) because it measures collection of sales. For intra-period measures, use 365 for a year or 90 for a quarter.
How CCC works — intuition
– You can think of CCC as the net time between cash outflow to buy inventory and cash inflow from customers.
– DIO and DSO increase the time before cash returns to the company (they are “cash-absorbing”).
– DPO delays cash outflow to suppliers (it is “cash-preserving”), so it reduces CCC.
– Tracking CCC over multiple periods shows whether working-capital efficiency is improving or deteriorating.
When CCC is most useful
– Retailers, distributors, and manufacturers: CCC is directly relevant because they buy and hold inventory.
– Businesses without inventory (software companies, brokers, many financial firms): CCC is not a useful efficiency metric.
– Some large retailers or platforms can report negative CCC if they collect cash from customers faster than they must pay suppliers or third-party vendors.
Step-by-step checklist to compute CCC
1. Choose the period (year = 365 days; quarter ≈ 90 days).
2. Pull figures from financial statements:
– Cost of goods sold (COGS) for the period.
– Revenue (sales) for the period.
– Average inventory = (Beginning inventory + Ending inventory) / 2.
– Average accounts receivable = (Beginning AR + Ending AR) / 2.
– Average accounts payable = (Beginning AP + Ending AP) / 2.
3. Compute:
– DIO = (Average Inventory / COGS) × Days.
– DSO = (Average AR / Revenue) × Days.
– DPO = (Average AP / COGS) × Days.
4. Compute CCC = DIO + DSO − DPO.
5. Interpret: compare to prior periods and to industry peers.
Worked numeric example
– Assumptions (annual):
– Average Inventory = $200,000
– COGS = $1,000,000
– Average Accounts Receivable = $150,000
– Revenue = $1,200,000
– Average Accounts Payable = $100,000
– Days = 365
– Calculate:
– DIO = (200,000 / 1,000,000) × 365 = 0.20 × 365 = 73 days
– DSO = (150,000 / 1,200,000) × 365 = 0.125 × 365 ≈ 46 days
– DPO = (100,000 / 1,000,000) ×
= (100,000 / 1,000,000) × 365 = 0.10 × 365 = 36.5 days (≈ 37 days)
– Compute CCC = DIO + DSO − DPO = 73 + 46 − 36.5 = 82.5 days (≈ 83 days)
Interpretation (worked example)
– A CCC of about 83 days means this company takes roughly 83 days, on net, to convert cash invested in inventory and receivables back into cash after paying suppliers. Put another way, working capital tied up in the operating cycle must cover about 83 days of operations.
– Is that good or bad? It depends on the industry and the company’s trend. Compare to:
– prior periods (is CCC shrinking or growing?),
– direct competitors and industry averages (some industries naturally have high CCCs — e.g., retail with long inventory turns vs. construction with long receivables).
– Operationally, a shorter CCC is usually better (less cash tied up), but aggressive cuts can harm sales or supplier relationships.
Practical steps to improve (action checklist)
– Reduce DIO (Inventory days outstanding)
– Improve demand forecasting and sales planning.
– Adopt just-in-time (JIT) or vendor-managed inventory where feasible.
– Rationalize SKUs and eliminate slow-moving stock.
– Use inventory turn KPIs and set reorder points.
– Reduce DSO (Days sales outstanding)
– Tighten or standardize credit terms; segment customers by risk.
– Invoice promptly and use electronic invoicing.
– Offer small early-pay discounts if economics allow.
– Use lockbox services, automated collections, or factoring only when necessary.
– Increase DPO (Days payable outstanding) without harming suppliers
– Negotiate longer payment terms or staged payments.
– Centralize accounts payable to capture full-term benefits.
– Use supply-chain finance / reverse factoring to extend supplier credit implicitly.
– Avoid unilateral stretching that damages supplier partnerships.
Measurement and monitoring checklist
– Frequency: calculate CCC monthly or quarterly to spot trends; use 365 days for annualized measures or the number of days in the reporting period (e.g., 90 for a quarter).
– Inputs required:
– Average Inventory = (Opening Inventory + Closing Inventory) / 2 (or a rolling average for more accuracy).
– COGS (cost of goods sold) for the period — ensure period matches days used.
– Average Accounts Receivable and Revenue (or sales) consistent with the period.
– Average Accounts Payable and COGS consistent with the period.
– Consistency: use COGS in DIO and DPO formulas (or purchases for DPO if preferred) but be consistent and document the choice.
– Adjust for seasonality: use rolling-12 or compare same-quarter year-over-year.
Limitations and caveats
– CCC is an operational metric, not a cash-balance measure. It ignores cash reserves, lines of credit, taxes, interest, and capital expenditures.
– Denominator mismatches: COGS may include non-cash items (depreciation). DPO sometimes uses purchases rather than COGS; this changes magnitudes.
– Accrual accounting: averages and timing can distort CCC if there are large one-off items, inventory write-downs, or changes in accounting policy.