The CCC time is dependent upon how a company finances its purchases, how it allows customers to pay (credit and the collection period), and how long it takes to collect. A lower CCC is an indicator of a faster inventory-to-sales process. A higher CCC indicates a slower process. A low CCC is generally accepted as more desirable, although this depends on your business, industry, and capabilities.
Elements of the Cash Conversion Cycle
Calculating the CCC may seem intimidating at first, but once you understand the elements involved in the calculation, it isn’t as confusing. You’ll need to reference your financial statements such as the balance sheet and income statement to give you information for the calculations. The cash conversion cycle formula has three parts: Days Inventory Outstanding, Days Sales Outstanding, and Days Payable Outstanding.
Days Inventory Outstanding
The first part of the equation is Days Inventory Outstanding (DIO). This is the average time to convert inventory into finished goods and sell them. Your average inventory (in value) for the period is your beginning inventory value + ending inventory value ÷ 2. The cost of goods sold is:
Days Sales Outstanding
Days Sales Outstanding (DSO) is the average amount of time in days that your accounts receivable (your business is owed money) are waiting to be collected. Your accounts receivable for this element are the average of your beginning and ending receivables.
Days Payable Outstanding
The Days Payable Outstanding (DPO) is the average length of time it takes a company to purchase from its suppliers on accounts payable—your business owes money—and pay for them. Accounts payable in this element is:
Calculating the Cash Conversion Cycle
Once you have calculated all three of the required elements of the formula, you can calculate the CCC.
Using the Cash Conversion Cycle
The CCC is good information, but really only useful if you are calculating it every year and comparing it—along with the three elements of the formula—to your business’ past performance. You may be able to compare your CCC to your competitors if their financial information is available. If it is not, you can use this metric to develop strategies to improve the time it takes to sell your inventory, collect on receivables, and pay your bills.
