The Cash Conversion Cycle (CCC) is one of the tools that can help manage the company’s assets and liabilities. Is your company’s CCC number good, bad, or really ugly?
The Meaning of a CCC Number.
The CCC is reported in days. The formula for the Cash Conversion Cycle is,
CCC = DIO + DSO – DPO
DIO = Days Inventory Outstanding (selling or turning over the entire inventory),
DSO = Days Sales Outstanding (number of days needed to collect the Account Receivables), and
DPO = Days Payable Outstanding (number of days, as agreed with suppliers, to pay the company’s bills)
The CCC metric measures the efficiency (performance) of the company when managing short-term assets and liabilities. The lower the CCC value is, the faster the company is converting cash to goods and back to cash again.
The CCC also is a measurement for liquidity, and how much risk exists should the company choose to invest in additional resources over the ‘short-term.’
Calculating the CCC Number.
Company ABC has an Inventory Turnover of 6.8 times per year. Currently ABC has 53 days of production inventory. ABC has ‘aged’ receivables of 40 days. The company has negotiated Accounts Payable terms of N55. Using the formula,
CCC = DIO + DSO – DPO
= 53 + 40 – 55
This measurement indicates overall performance, but it must be taken in context. The result should be compared to other companies and their CCC numbers in the same industry.
Interpreting the CCC Number.
Let’s say that the business in the above example is using raw materials in production that are commodities. This means their purchasing lead times should be short (let’s say five days). Let’s also state that the company’s manufacturing lead time is ten days.
With these two premises in mind, the company should have a very low CCC number (if they have also managed their DSO and DPO numbers).
Conversely, if the same company above has two months of production inventory on-hand, then the company will probably have a higher CCC number meaning that its Cash Conversion Cycle is too long.
It is important to realize that there can be other reasons for a higher DIO or CCC numbers, e.g., the company may not be meeting customer order ship dates due to planning and/or execution issues.
The Bottom Line. The Cash Conversion Cycle number is just one of the tools available to review company management of assets and liabilities. The number is used to measure how fast the company converts cash to goods and back to cash again. A lower CCC number, if found to be comparatively equal to other businesses in the same industry, can indicate effective management of the company’s Cash Conversion Cycle.