The Cash Conversion Cycle is an important metric that indicates the time it takes a business to convert the money it spends on business costs, such as inventory and operations, back into cash by making sales.
If you run a business and are attempting to manage your overhead costs, learning how to improve your business’s cash cycle can help you reduce expenditures, streamline your day-to-day operations, and better manage your cash income. ICL is here to help you learn more about the cash flow cycle and how to make it work for your needs.
ICL’s software-first CashSimple™ solution streamlines everything from change orders to tracking deposits.
What Is the Cash Conversion Cycle (CCC)?
The Cash Conversion Cycle (CCC), also known as the cash-to-cash cycle, helps businesses measure how long it takes to convert their investments in inventory and other resources back into cash flow from sales.
This business operating cycle is imperative for measuring how efficient a company is, how well-managed its assets and capital are, and the overall financial success of the business. Businesses can also use the money cycle to determine any potential issues within their operations to improve inventory management, cash expenditures, and other financial metrics.
Parts of the CCC
The Cash Conversion Cycle uses three critical elements: inventory, accounts payable, and accounts receivable:
- Inventory: Inventory is the amount of goods a business has on hand. Ideally, the company will sell all of this inventory, contributing to the cash conversion period.
- Accounts Payable: This refers to the amount of money that a business owes to investors, suppliers, and other entities, like insurance companies and more.
- Accounts Receivable: Lastly, accounts receivable is the amount of money the business is owed from customers or other parties. Essentially, this is the company’s uncollected invoices.
Cash Conversion Cycle Formula
The cash conversion formula is calculated by gathering different types of data and information:
- Inventory over a specific amount of time
- The annual revenue the company makes
- How long it takes the company to collect payments
- The average cost of goods or services
- How long the company holds onto inventory before selling it
You categorize learning how to calculate Cash Conversion Cycle amounts into three distinct features: days inventory outstanding (DIO), days sales outstanding (DSO), and days payable outstanding (DPO).
More specifically, the cash cycle equation is DIO + DSO – DPO.
Days Inventory Outstanding (DIO)
Days inventory outstanding is the average number of days a company holds onto inventory before selling it. Ideally, the smaller this number is, the better. It indicates that your business can quickly cycle through inventory to convert to cash, and increase sales.
You calculate this by dividing your average inventory by the cost of goods sold, and then multiplying this by the number of days you are trying to determine for your cash cycle. You can calculate this for weekly, monthly, or annual sales.
Days Sales Outstanding (DSO)
Days sales outstanding is the average number of days it takes your business to collect payment from customers or other vendors after making a sale. Yet again, the smaller the number is, the better. This means you can collect payments and revenue quickly, ensuring you can use this money for other business expenditures or investments.
To calculate days sales outstanding, multiply accounts receivable by the number of days and divide this by total credit sales.
Days Payable Outstanding (DPO)
Lastly, days payable outstanding is the average number of days a business takes to pay its bills, bank invoices, suppliers, and other necessary needs.
As opposed to the other two metrics, businesses want this number to be higher, as it indicates that the company can hold onto cash longer. This maximizes and increases investment potential and the ability to create larger holdings. However, this isn’t always the case.
Outsourcing to a solution like CashSimple™ can solve the hidden costs often associated with cash in transit services.
Analyzing the Cash Conversion Cycle
In general, the Cash Conversion Cycle should be shorter rather than longer. A lower CCC typically shows that a company utilizes its resources, inventory, and investments much more efficiently. However, you must consider other financial metrics, such as return on equity and return on assets, to create a more expansive picture of your company and its success.
Also, it’s important to not only look at a single year’s CCC. For the most effective and reliable data, consider how your business performs over multiple years. This will help you determine potential areas for improvement, seasonal needs, and other essential indicators for overall success. Other influences, such as market trends, economic conditions, and local banking changes, can also drastically change your company’s Cash Conversion Cycle.
Negative CCC
A negative Cash Conversion Cycle generally indicates that a company can finance its inventory through payable accounts using supplier credits to fund operations and conduct necessary business matters. Businesses can achieve a negative CCC by:
- Collecting payment from customers quickly and efficiently
- Paying their suppliers at a later date (however, this shouldn’t be too long of a period)
- Selling inventory rapidly
However, achieving a negative CCC is extremely difficult for many businesses unless they take extreme measures such as conducting dangerous, unsustainable, or unethical practices.
Why the Cash Conversion Cycle Matters
Overall, the importance of the Cash Conversion Cycle lies in its ability to provide insights into a company’s liquidity, efficiency, and overall financial health and performance. The CCC indicates a faster inventory-to-sales process, showcasing that, in most cases, businesses have strong sales practices and can hold onto money for investments, business needs, and other benefits.
Managing your company’s CCC is crucial for sustaining operations and supporting the growth of your business. Integrated Cash Logistics and our smart safe technology can help your business streamline business operations, better manage your money, and eliminate risks of provisional credit. These tactics all work together to give the insights you need to improve your CCC.
For most retailers, provisional credit is the only option, but CashSimple™ does more.
How to Improve the Cash Conversion Cycle
If you want to improve your company’s Cash Conversion Cycle, there are many strategies you can incorporate into your business practices. Most importantly, take a holistic, comprehensive approach to managing your CCC and be mindful of cash flow management. However, be careful that focusing too much on strategy can lead to negative results that may impact your business relationships with vendors and clients.
Here are some of the most effective ways to improve your Cash Conversion Cycle:
- Evaluate Vendor Health and Stability: One way to improve your CCC is by evaluating the health of your vendors. If you see that you can delay payments to vendors for a bit longer and that this is sustainable, this can improve your CCC. However, ensure that this doesn’t damage your business relationships.
- Evaluate Account Receivable and Invoice Processes: You can also evaluate how quickly you receive payments from customers. If you can improve receiving payments without being overly aggressive, this can aid your CCC. One way is to make bills payable online or through other technologies.
- Streamline Inventory Management: Reducing the time it takes for your inventory to arrive and sell can also improve your CCC. One method to do this is to hold more stock in general and regularly reassess your demands.
- Assess Customer Credit Criteria: Lastly, work to improve your CCC by assessing your customer credit criteria. Improve the process of identifying financially healthy customers to reduce payment processing time.
Change How Your Business Manages the Cash Conversion Cycle with CashSimple™
If you are hoping to improve your Cash Conversion Cycle, look no further than Integrated Cash Logistics and our CashSimple™ technology. Our smart safes are driven by our proprietary software. Our configurable portal and real-time reporting allow you to accurately access your company’s money reports as often as needed, helping you meet your unique needs and goals.
For more information about how Integrated Cash Logistics can work with your business and improve its overall bottom line, reach out to our team today or schedule a demo. Our goal is simplifying how your business controls cash, ensuring that you and your business can prioritize what matters most.
