If you run a business, there are certain indicators that you should be keeping an eye on. Most are obvious like revenue, profit, and expenditures. But one of the most useful, yet underused, is the Cash Conversion Cycle.
The Cash Conversion Cycle is a business metric that measures the time it takes your business to convert cash into inventory, then to sales, and back to cash. It’s also known as cash-to-cash cycle time, cash cycle, or net operating cycle.
It’s a beneficial metric in measuring and understanding your business's efficiency in management and operations. The net operating cycle applies only to companies that depend on inventories and inventory-related operations.
The cash cycle is calculated using a simple formula:
Your Cash Conversion Cycle score = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) - Days Payable Outstanding (DPO)
To fully understand the formula and how it works, let’s take a look at each component.
Days Inventory Outstanding refers to the average amount of days it takes for your business to convert its inventory into saleable items and then sell them. This may include manufacturing products or simply delivery time for resale goods.
To get the most accurate DIO, you need to find your average inventory time, divide it by the cost of goods sold then multiply the findings by the number of days in the year.
Days sales outstanding is the average number of days your business takes to collect its receivables. This is the time it takes for your customers to pay once you’ve made a sale. With DSO, you take your receivables, divide them by the net credit sales then multiply the findings by the number of days in the year.
Days payable outstanding refers to the number of days your business takes to pay back your suppliers’ invoices. DPO is calculated by using the ending accounts payable and then dividing them by the cost of goods sold and dividing that by the number of days in the year.
Once you’ve put your own figures through the Cash Conversion Cycle formula, you’ll have your company’s CCC. But what does this number mean? How do you know if it’s good or bad? Read our next blog in this series to learn What your Cash Conversion Cycle score means.
Read more on our Cash Conversion Cycle series 1. How to calculate your Cash Conversion Cycle score 2. What your Cash Conversion Cycle score means 3. How to shorten your Cash Conversion Cycle 4. Benefits Of Knowing Your Cash Conversion Cycle score
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