How to Calculate the Cash Conversion Cycle

Last Updated September 13, 2023

When you’re running a small business, you must know several formulas to keep expenses low and maintain high-profit margins.

Other formulas present business owners opportunities to know how fast their inventory is selling and tracking cash flow, called the cash conversion cycle (CCC). It’s also known as the net operating cycle.

Read on to find how to calculate the cash conversion cycle and why it’s essential for small business owners to know.

What You Need to Calculate Cash Conversion Cycle

To calculate your company’s cash conversion cycle, you need the following from cash flow statements and other financial statements:

• Cost of goods sold and revenue from the income statement
• Inventory at beginning and end of the period
• Accounts receivables at beginning and end of the period
• Accounts payable at beginning and end of the period
• Number of days in the period (ex. 365 annually, 90 quarterly)

Basics of the Cash Conversion Cycle

There are three parts to the cash conversion cycle. Continue to find out each formula and ultimately how to calculate the cash conversion cycle.

Days Inventory Outstanding

The average time to convert inventory into finished products to sell is called Days Inventory Outstanding (DIO).

Use the average of the accounts receivable:

• (Beginning receivables + ending receivables) / 2

The cost of goods sold (COGS):

• Beginning inventory + purchases – ending inventory

Using that, the formula for DIO is:

• (Average Inventory / COGS) x 365

Days Sales Outstanding

The average amount of days your accounts receivable is waiting to be collected is called the Days Sales Outstanding (DSO).

The accounts receivable for DSO is the average of the company’s beginning and ending receivables, which looks like this:

• (Beginning receivables + ending receivables) / 2

The formula for DSO is:

• (Accounts receivable/net credit sales) x 365

Days Payable Outstanding

The company’s average days to purchase from suppliers on accounts payable and pay them is called Days Payable Outstanding (DPO).

Calculate your accounts payable using:

• (Beginning payables + ending payables) / 2

The formula for DPO is:

• Ending accounts payable / (COGS / 365)

How to Calculate Cash Conversion Cycle (CCC)

Now that all three parts are established, the formula for the cash conversion cycle (CCC) is:

• DIO + DSO – DPO

A low CCC is most desirable, depending on your industry, as it indicates a fast inventory-to-sales pipeline. If the company’s CCC is high, chances are the process is slow, which means you may sell at a loss to keep the cash flow moving if you do not receive receivables in time.

Why is Cash Conversion Cycle Important for Small Business Owners?

The cash conversion cycle essentially depends on how your company finances its purchases, receives payment, and how it takes to process.

In business, time is money, and the longer inventory clears, means less cash flow.

When cash is readily available, the business can continue to convert sales into profit as you’re ready to buy supplies and continue the process.

The CCC is also a formula used to compare to other companies. If a competitor has their financial statements public with the CCC readily available or enough information to calculate the CCC, evaluate, compare, and contrast.

Many companies use CCC yearly, although there are advantages for CCC quarterly reporting, as you can track to see improvements in your business and if there are any inefficiencies.

Some inefficiencies include poor inventory management, marketing, sales realization, and failures to receive and pay. The CCC also indicates how well the company uses short-term assets and liabilities to create profits, revealing the company’s health.

Conclusion

Overall, learning how to calculate the cash conversion cycle is a powerful tool every small business owner should know. It may seem challenging at first, but understanding your inventory and how fast it can convert, tied with your ability to meet payments, may change how you run your company. The CCC is also essential when combined with other elements, such as profit margins, debt-to-equity ratio, and other formulas.

If your business is struggling with cash flow issues, you may also be a fit for factoring services. Factoring is a form of alternative lending that unlocks working capital by turning your outstanding receivables into cash.