Most business owners keep a keen eye on their cash flow – particularly when it comes to avoiding a cash flow gap. But fewer are familiar with the cash conversion cycle (CCC). Here’s what you need to know.

The cash conversion cycle (CCC) is an important metric that can help you take control of your business finances and manage your cash flow effectively. Whether you’re looking to avoid a cash flow gap, or identify when extra funds are available, the CCC formula is a powerful tool that every business owner should know.

What’s the cash conversion cycle?

Your CCC is the time in days it takes to convert the money you spend producing a product or service into revenue. A smaller CCC is therefore better – as it means you’re managing your cash flow more efficiently.

You can calculate your CCC using the formula CCC = DIO + DSO – DPO

Where:

  • DIO: Days Inventory Outstanding - how long it takes to produce and sell your goods or services.
  • DSO: Days Sales Outstanding - how long it takes to receive payment from your customers.
  • DPO: Days Payable Outstanding - how long it takes you to pay your suppliers.

Let’s look at some examples:

Example 1 – how to manage cash flow in retail

Fred is a wholesaler who sells bikes to retail bike stores. He buys the bikes from the manufacturers who have 60-day payment terms (DPO). His retailers pay him within 90 days (DSO). Generally, he has the bikes for about 30 days (DIO) before getting them to his retailers.

30 (DIO) + 90 (DSO) – 60 (DPO) = 60

Based on this, Fred’s CCC is 60 days – which means he needs to have enough working capital to cover an average 60 days of operational costs before he will be paid. To increase efficiency and shorten the CCC, he could look at renegotiating payment terms with his suppliers and customers, or moving the stock to the retailers earlier.

Example 2 – how to manage cash flow in construction or a services business

Hardhats is a labour hire firm that places construction workers. Workers are paid every 14 days (DPO). Hardhats receives payment from its clients 30 days after invoicing them (DSO). It takes on average 10 days to find work for each Hardhats contractor (DIO).

10 (DIO) + 30 (DSO) – 14 (DPO) = 26

The CCC of Hardhats is 26 days. That means they have to cover an average of 26 days of salaries and operational costs before their investment is recouped.

So what’s a good benchmark?

It’s hard to give an absolute CCC benchmark to aim for, as conditions vary widely between industries and business models. As such, you may find it helpful to compare your CCC with competitors in your industry.

Some businesses, like online retailers, may have a negative CCC, as they don’t hold on to inventory for long and receive payment for sales before paying suppliers. Telecommunications companies may also have a negative CCC, as they often take payment before providing the service.

On the other hand, car manufacturers have a high CCC. That’s because they need to order well in advance and have to allow time for shipping and moving cars via the showroom floor.

How the CCC helps with cash flow management

Understanding your CCC can help you identify any areas in your business that are choke points or opportunities for greater liquidity. This can help you avoid any cash flow gaps and let you know when extra cash is available to invest in your business.

Learn more about cash flow management

For more cash flow management tips and a look at the causes of cash flow issues, check out our article on 7 tips for managing your business cash flow.

Things you should know

  • This article is intended to provide general information of an educational nature only. It does not have regard to the financial situation or needs of any reader and must not be relied upon as financial product advice. As this information has been prepared without considering your objectives, financial situation or needs, you should, before acting on this, consider the appropriateness to your circumstances. Examples used in this article are for illustrative purposes only.

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