• How to calculate a cash conversion cycle
• Consderations for a good benchmark
• How the cash conversion cycle helps with cash flow management

Cash flow. There aren’t many more pleasant-sounding pairs of words in the English language to business owners. Until it stops flowing. Then it becomes a pressure point you just can’t avoid, as invoice payments slow, running costs rise and opportunities pass you by. When in a cash flow crisis, many small business owners may find themselves too caught up in the day-to-day to really study their cash flow pressure points – and understand how they can get around them. This is where the cash conversion cycle (CCC) comes in. It’s a quick and easy sum that helps you calculate the health of your business and can set you up for success. Read on to learn the sum every small business owner is going to be talking about this year.

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.