Stock Research Pro

The cash conversion cycle (CCC) is a measure of the time it takes a company to convert its resources to cash. The CCC is the total time it takes for the company to convert its resources into inventories, then into finished products for sale, then the conversion of those products into accounts receivable and then the conversion of those into cash. The cash conversion cycle, then, includes a combination of several ratios involving accounts receivable, accounts payable and inventory turnover. This CCC measure allows an investor to gauge the overall health and efficiency of the company and is most effective with retail types of companies as they have inventories that are sold to customers.

The Cash Conversion Cycle Formula

The formula for the cash conversion cycle can be written as:

The Inventory Conversion Period indicates the number of days it takes the company to sell off the inventory. Obviously, a smaller number is better.

The Receivables Conversion Period examines the number of days the company needs to collect on its invoices. Again, a smaller number is better.

The Payables Conversion Period looks at the company’s payment of its own bills or accounts payable. In this case, a larger number is better as the company then holds its cash longer and maximizes its investment potential.

As you can see, the cash conversion cycle presents a vital ratio because it represents the number of days a firm’s cash remains tied up within the operations of the business. It should make sense then that a downward trend in this measure is a good sign while an upward trend can be cause for concern. It is a useful exercise to calculate the CCC for the same time periods of the company’s competitors.

_______________________________________________________________

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.