Cash Conversion Cycle

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 several use cases that are of interest to different stakeholders. Let me 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

GoodA car manufacturer that uses "just-in-time" production minimizes its storage costs and sells cars almost as quickly 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.