Small Business Advice

Cash conversion cycle: What it is & how to calculate

The cash conversion cycle is an important financial measure for any business that buys and manages inventory. In this post we explain how to use it to determine your company's financial health.

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The cash conversion cycle is an important financial measure for any business that buys and manages inventory. In addition to showing the financial health of a company, the CCC cycle also indicates whether or not the business is operating efficiently.

That said, this metric should not be used in isolation. Rather, look at it alongside other measures, like return on equity, to properly determine if your company is profitable. In this article, we look at the cash conversion cycle formula, the 3 components of the cash conversion cycle, and everything you need to know. But first, the basics.

What is a cash conversion cycle?

The cash conversion cycle is a formula that measures how long it takes for a company to convert its inventory into cash. Usually abbreviated as CCC, the cash conversion cycle is also known as the net operating cycle or simply the cash cycle. It tells you how long your business takes to sell inventory, collect accounts receivable, and settle accounts payable.

At the very least, the CCC cycle represents the amount of time (in days) it takes for a company to move its inventory through the sales and distribution process. It also shows how long it takes for the company to turn accounts receivable into liquid capital. As a business owner, this information helps you understand how efficient your company’s operations are. It also gives you a clearer picture of the stages in the process that are least efficient at bringing in cash flow.

The lower the cash conversion cycle, the more efficient the business is at inventory turnover. For example, if the CCC is negative, then it means the company’s working capital turns back into cash very quickly.

Something worth mentioning is that only businesses that have inventory can use the cash conversion cycle metric. Such businesses include retail stores, wholesalers, e-commerce sellers, car dealerships etc.

The cash conversion cycle has 3 elements, namely Days Inventory Outstanding (DIO), Days Sales Outstanding (DSO), and Days Payable Outstanding (DPO).

  1. Days Inventory Outstanding (DIO): this metric measures the average time it takes to convert inventory into finished products then sell them. The way to calculate it is dividing your average inventory by the cost of goods, then multiplying by 365.

DIO = Average InventoryCost of Goods Sold x 365

Days Inventory Outstanding (DIO) Formula

  1. Days Sales Outstanding (DSO): DSO indicates the average number of days that your business takes to collect accounts receivable. You can calculate it by dividing average accounts receivable by net credit sales, then multiply by 365.

DSO = Average Accounts ReceivableTotal Credit Sales x 365

Days Sales Outstanding (DSO) Formula

  1. Days Payable Outstanding (DPO): this value measures the average amount of time that your business takes to make purchases and pay for those purchases. In other words, it shows how long you take to settle accounts payable. To find DPO, divide average accounts payable by cost of goods sold, then multiply by 365. You can also use ending accounts payable in place of average accounts payable.

DSO = Average Accounts PayableCost of Goods Sold x 365

Days Payable Outstanding (DPO) Formula

How to calculate the cash conversion cycle

The cash conversion cycle formula is expressed as:

Cash Conversion Cycle = Days Inventory Outstanding + Days Sales Outstanding – Days Payable Outstanding

In short form, the cash conversion cycle formula is: 


The aforementioned section covers how to find DIO, DSO and DPO. One thing about the cash conversion cycle formula is that it uses variables that you can pick directly from a company’s financial statements, including the income statement and balance sheet. For example, you can find the cost of goods sold on the income statement. Both the ending and beginning inventory (used for calculating average inventory) can be found on the balance sheet.

Cash conversion cycle example

Say, for example, that your company reported average inventory of $4,000 and an additional $50,000 in cost of goods sold. Then, assume that over the same fiscal period, your average accounts receivable was $5,000, the total credit sales were $150,000, and the average accounts payable was $2,000. Here’s how you would calculate the 3 elements of the cash conversion cycle:

DIO = 4,00050,000 x 365 = 29.2

This DIO means your company takes roughly 29 days to turn inventory into sales.

DSO = 5,000150,000 x 365 = 12.2

This DSO means that your company takes about 12 days to collect invoices.

DPO = 2,00050,000 x 365 = 14.6

This DPO means that your company takes about 15 days to pay for invoices.

Since, the cash conversion cycle formula is DIO + DSO – DPO, substitute the values to get:

CCC = 29 + 12 – 15 = 26

Thus, your cash conversion cycle would be 26 days. That’s the number of days that your company takes to turn its cash investment in inventory back into cash.

What is a good cash conversion cycle?

A good CCC is a short one. To run an efficient and profitable business, you want to make the cash conversion cycle as low of a number as possible. Ideally, you should work to bring it closer to 1 because then it means that your business has great liquidity and its working capital is not tied up for long periods. If it’s negative, then your inventory turnover is instant.

Most online-only retail companies have negative cash conversion cycles because they don’t hold inventory. Instead, they drop-ship products. This means they don’t actually pay for inventory until customers place orders, which results in the business getting paid right away.

Such a business model is practically impossible if you run a brick-and-mortar business like a physical store. In that case, you’ll always have inventory in the business. And if you sell to some customers on credit, then you’ll certainly have a positive CCC. The value will be especially high if you give NET 30, NET 60 and NET 90 credit terms.

That said, there are measures that you can take to shorten the business’s cash conversion cycle. Top on the list is ensuring that your invoices are paid for on time. This makes the accounts receivable process efficient.

Not sure how to make an effective invoice that can be paid for on time? Check out this guide.

Operating cycle vs cash conversion cycle

What is the difference between operating cycle and cash conversion cycle? In simple terms, the operating cycle refers to the duration (in days) between when you buy inventory and when your customers pay for that inventory. The cash conversion cycle, on the other hand, measures the number of days between when you pay for inventory and when your customers pay you for the same inventory.

What does the operating cycle indicate? This metric estimates the amount of working capital that your business needs in order to grow or maintain. If your operating cycle is short, then it means you require less cash to run operations. The business can still grow even if you’re selling inventory at small profit margins.

Understanding cash conversion cycle & cash flow

Simply put, the cash conversion cycle measures the amount of time it takes for a business to turn inventory into cash. It’s at times referred to as the cash-to-cash cycle because it estimates the period between when you pay for inventory and when customers pay for the same inventory.

Customer payments replenish your company’s cash flow. If they take too long to pay invoices, it means that most of your cash and working capital will be tied up. This may prevent you from taking up new customers, particularly if your business works with heavy inventory demands (like a construction company).

The bottom line is, the cash conversion cycle will give you an idea of how long it takes for your business to collect cash payments from customers. It, therefore, helps you determine whether the process of cash flowing in and cash flowing out is efficient. A low CCC cycle creates a positive cash flow while a high CCC cycle puts you at risk of a negative cash flow. This is what makes it very important to keep a keen eye on your business’s cash conversion cycle.

Why is a good cash conversion cycle important?

A good cash conversion cycle is important primarily because it signifies that a company’s inventory chain is running efficiently. As already mentioned, your CCC is good if it’s low. On the other hand, if your company’s CCC is high, then it means that you have either inventory or financial management issues. Either of these two can cause serious cash flow problems.

Financial, inventory and cash flow efficiencies are not the only reasons why a good cash conversion cycle is important. Here are some more:

Improves business operating efficiency: pushing your CCC cycle low indicates that you’re doing a great job at converting inventory into cash. This, in turn, means that your business is operating efficiently. On the other hand, a high cash conversion cycle could imply operational challenges, a decline in your market niche or a lack of demand for your products. Whatever the case, a bad CCC implies that there’s an issue that needs correcting for your business to run efficiently.

Better terms for trade lines: some suppliers will look at your cash conversion cycle when deciding whether or not to give your company trade lines. If your CCC is low, then it means that your business has sufficient liquidity. In which case, suppliers and vendors won’t worry about extending tradelines to you.

Easier access to loans and capital: a good cash conversion cycle doesn’t just increase your chances of getting trade lines, it also improves the likelihood of getting approved for business loans. The reason behind that is simple. If you have a low CCC, then your business’s liquidity is healthy. To lenders, this means that you can comfortably pay back loans that are advanced to you. Such a sense of security increases their likelihood of approving your loan applications.

Here are 11 types of business loans and how to choose one that fits your business.

Good debt management: as already mentioned, the CCC of a company has an influence on its cash flow. By analyzing this measure, you can correctly determine whether your company is strapped for cash or if you have enough of it. Thus, it can help you figure out whether or not to ask lenders for money and how much of it to ask for.

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