Cash Conversion Cycle

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What is the Cash Conversion Cycle (CCC)?

The Cash Conversion Cycle (CCC) - also known as the cash cycle - is a key figure for the operating capital, which indicates how many days it takes a company to turn cash into inventories and then back into cash via the sales process. The shorter a company's CCC, the shorter the time the company has cash tied up in its receivables and inventories.

The Cash Conversion Cycle is an important key figure for E-commerce companies that purchase and manage inventory, as it is an indicator of operational efficiency and financial health. However, it should not be considered in isolation, but in conjunction with other financial metrics such as return on equity. It is also important to note that the CCC is not relevant for all companies, as not every company holds physical inventory.

What can the CCC tell you about your e-commerce business?

The goal of each E-commerce stores is to make a profit. And having a lot of liquid cash helps with that. When capital is readily available, you can buy more goods and make more sales.

On the other hand, working capital stuck in inventory can reduce revenues and lead to a liquidity crisis. Therefore, a low CCC is always desirable.

In this way, the CCC can be thought of as a sales efficiency calculation. It shows how quickly and efficiently a store can buy, sell and collect its inventory.

Significance of the Cash Conversion Cycle

The typical length of the Cash Conversion Cycle varies considerably depending on the industry, so there is no single value that represents a "good" or "bad" Cash Conversion Cycle represents. However, it can be useful to compare the CCC of two companies in the same industry, as a low CCC may indicate that one company is managing its working capital more effectively than the other. It can also be useful to track the CCC of an individual company over time, as this can show whether the company is becoming more efficient or less efficient.

Company and E-commerce Stores can use the Cash Conversion Cycle so improve in different ways:

  • Turn inventory into sales faster
  • Collect payments from customers faster
  • Extend the time for payment of suppliers

Calculation of the cash conversion cycle

The Cash Conversion Cycle includes three important phases of a company's sales activity:

  • Selling the current stock
  • Collecting cash from current sales
  • Payment of suppliers for purchased goods and serviceservices

Therefore, CCC is calculated using three other working capital metrics: Days Inventory Outstanding (DIO), Days Sales Outstanding (DSO), and Days Payable Outstanding (DPO). DIO and DSO are current assets, while DPO is classified as a liability.

Formula for the cash conversion cycle
The formula for the Cash Conversion Cycle is as follows:

Cash Conversion Cycle = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) - Days Payables Outstanding (DPO)

Whereby:
DIO = Days Inventory Outstanding (average inventory/cost of sales x number of days).
DSO = Days Sales Outstanding x number of days/total credit sales)
DPO = days sales outstanding (trade payables x number of days/cost of goods sold)

So, for example, if a company has a DIO of 90 days, a DSO of 20 days, and a DPO of 55 days, its Cash Conversion Cycle calculated as follows

CCC = 90 + 20 - 50

= 50 days

For whom is the Cash Conversion Cycle relevant?

The Cash Conversion Cycle (CCC) has multiple use cases that are of interest to different stakeholders. I'll give you a few examples:

For entrepreneurs:

  1. Liquidity management: If you run a business that's in manufacturing or retail, the CCC gives you a quick overview of how well you're doing your Liquidity manage. Let's say you run a company that makes wooden furniture. You have to buy wood, screws and varnish and then assemble the things. The CCC shows you how long it takes for these expenses to become revenue, that is, for the customer to pay.
  2. Optimization of business processes: A high CCC can be a warning that you are working inefficiently somewhere in the process. Maybe you're buying materials too early, or your manufacturing processes are too slow, or your invoicing and payment receipts are not optimally timed.

For investors:

  1. Business Valuation: If you're looking to invest in companies, the CCC can give you a quick assessment of how well the company is using its capital. A low CCC is usually a good sign and can mean that the company has a good track record. higher return on investment has.

For lenders:

  1. Credit score: Banks and other financial institutions look at the CCC to assess how risky a loan is for a company. A high CCC can be a sign that the company may have difficulty repaying the loan, especially if there are shortages in the Cash flow comes.

For supply chain management:

  1. Supplier Management: The CCC can also be used to evaluate supply chain efficiency. For example, if you are a retailer sourcing goods from multiple suppliers, a short CCC with one supplier compared to another could be an indication that you should do more business with that more efficient supplier.

So, whether you're an entrepreneur, investor or lender, the Cash Conversion Cycle is a versatile tool that gives you important insights into the financial efficiency of a company. It's a metric you shouldn't ignore.

What makes good and bad cash conversion cycles?

let's look at different industries and how a good or bad Cash Conversion Cycle (CCC) could look like there:

1. retail - supermarket

Good: A supermarket with a short CCC is super efficient. It sells goods almost as soon as they arrive, and since many payments are immediate (cash or card), the money doesn't stay in the system for long. This increases liquidity and minimizes financing costs.

Bad: A supermarket that stores products for a long time or has problems with product rotation will have a longer CCC. This ties up capital and can lead to spoilage, which in turn increases costs.

2. automotive industry

Good: An automaker that uses "just-in-time" production minimizes its inventory costs and sells cars almost as fast as they are produced. Low storage costs and fast turnaround times are crucial here.

Bad: An automaker with a high CCC may have too many unsold cars in stock. Capital is tied up, and there may be storage costs that reduce profits.

3. SaaS company (Software as a Service)

Good: Here, the CCC is often close to zero or even negative because customers pay upfront for subscriptions while the cost of service accrues over time. A negative CCC is desirable in this case and speaks for a healthy business model.

Bad: A SaaS company with a high customer acquisition cost (CAC) and a high churn rate will have a high CCC because it takes a long time to get back the money invested. Customer retention is critical in this case.

4. real estate industry

Good: A real estate developer who enters into preliminary contracts for condominiums can use the capital raised to finance construction costs. Here, the CCC can be extremely short.

Bad: A real estate company that owns completed buildings that are not leased or sold has a high CCC. The capital is tied up, and in addition there are costs for the maintenance of the properties.

5. gastronomy

Good: A restaurant that orders fresh ingredients on demand and consumes them quickly has a short CCC. Efficient ordering and preparation processes are the key here.

Bad: A restaurant that stocks ingredients in large quantities and has an inefficient kitchen will have a longer CCC. This leads to higher storage costs and possibly spoilage.

Hopefully these examples will help you to get a better understanding of the Cash Conversion Cycle and its importance in various industries. In any case, a short or even negative CCC is desirable as it increases the financial efficiency of the company.

Conclusion

Sure, the Cash Conversion Cycle (CCC) is basically like the metronome of your business. It tells you how fast you can get through the whole process from acquiring goods or raw materials to collecting payments from customers. And believe me, in the world of business, speed is often synonymous with efficiency.

Look at a SaaS company, for example. People pay upfront for an annual subscription. Your biggest concern then is really just server costs and customer service. The cash flow is quasi instantaneous, and your CCC is approaching zero or even negative. It's like a dream run on a Treadmill, where you gain more energy than you expend.

But not everyone is so lucky. Think of a traditional automotive company. There, the warehouse is overflowing with parts or even finished cars. People don't buy a new car every day. Months can pass before you convince them, a sales contract is signed and the money is in the account. A long CCC in such a case can really become a nightmare, especially if loans have to be repaid or storage costs increase.

And then, of course, there are industries like retail. Imagine you run a small organic supermarket. If you order too many fresh products and don't sell them in time, your CCC will deteriorate dramatically. Every day that the apples are in the fruit display is a day that your capital is tied up.

No matter what industry you're in, a short CCC is often a sign that you're doing things right: You turn your capital around quickly, tie up less money and are more efficient overall. A high or even rising CCC, on the other hand, should be seen as a warning signal. It is an indication that you should either optimize your inventory, collect your receivables faster or renegotiate your payment terms with suppliers.

So, whether you're in the software industry or food retail, the CCC is like the pulse of your business. The lower, the better. The higher, the more you should think about how to become more efficient.

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FAQ

What is the Cash Conversion Cycle? arrow icon in accordion
The Cash Conversion Cycle (CCC) is a financial metric that indicates how long it takes for a company to convert its investments in raw materials, labor, and other resources into cash. The CCC measures the time it takes for a company to purchase raw materials and convert them into final products sold that are available as cash.
How is the cash conversion cycle calculated? arrow icon in accordion
The cash conversion cycle is usually calculated by adding the average inventory holding time, the average receivable time and the average payment time. The average inventory holding time corresponds to the average time required by a company to purchase raw materials and convert them into saleable end products. The average receivable time corresponds to the average time it takes a company to sell its products and pay its customers. The average payment time corresponds to the average time it takes a company to pay its suppliers' invoices.
Why is the cash conversion cycle important? arrow icon in accordion
The cash conversion cycle is important because it is a key measure of a company's liquidity. A low cash conversion cycle means that a company converts its investments into cash more quickly and has higher liquidity. A high cash conversion cycle, on the other hand, means that a company converts its investments into cash more slowly and is less liquid.
How can a company improve the cash conversion cycle? arrow icon in accordion
A company can improve the cash conversion cycle by shortening its inventory holding time, receivables time and payment time. To shorten inventory time, a company can optimize its warehouse management and make its production processes more efficient. To shorten its receivables time, a company can speed up its invoicing and automate its customer accounting processes. To shorten payment time, a company can improve its supplier relationships and implement a system of electronic payments.
What is the optimal cash conversion cycle rate? arrow icon in accordion
There is no single optimal cash conversion cycle rate, as each company may have a different CCC rate based on its business model, market conditions and other factors. However, a company should try to minimize the cash conversion cycle by making its inventory time, receivables time and payment time as efficient as possible.
How to compare the cash conversion cycle of a company? arrow icon in accordion
To compare the cash conversion cycle of one company with that of another, both companies need to calculate their inventory time, receivables time, and payment time and compare their CCC. A company can also compare the CCC of other industries to see how its CCC compares to the industry.
How can investors assess a company's cash conversion cycle? arrow icon in accordion
Investors can assess a company's cash conversion cycle by calculating the company's average inventory time, average receivables time, and average payment time, and comparing the CCC to that of other companies in the industry. A low CCC indicates sound financial management and good liquidity position.
What is a negative cash conversion cycle? arrow icon in accordion
A negative cash conversion cycle means that a company is converting its cash investments faster than it is paying its bills. This means that the company has cash that it can use to pay its bills before it pays its customers.
When should a company aim for a negative cash conversion cycle? arrow icon in accordion
A company should aim for a negative cash conversion cycle if it has cash that it can use to pay its bills before it pays its customers. A negative cash conversion cycle can also be helpful if a company wants to improve its liquidity position by shortening payment times.
How can a company monitor its cash conversion cycle? arrow icon in accordion
A company can monitor its cash conversion cycle by measuring the average inventory time, average receivable time, and average payment time, and monitor the CCC on a regular basis. A company can also compare data on the CCC of other companies in its industry to gain a better understanding of how its own CCC is developing.

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