Because "time is money", master your Cash Conversion Cycle.

A balanced cash position is undoubtedly a sine qua non for a company's success and long-term viability. Successful organizations are those which have made it part of their daily routine to monitor various financial indicators: net income, EBITDA, working capital, debt ratio, etc. Among these, the Cash Conversion Cycle (CCC) plays a key role.

Among these, the Cash Conversion Cycle (CCC) plays a key role, as it shows how long it takes to convert investments into cash. In other words, it shows how quickly your cash is freed up to support your ambitions, among other things.

A rather interesting KPI, don't you think?

Well, the Cash Conversion Cycle is our topic of the day. On the program: the definition, the formula for calculating it and, of course, some valuable tips for improving your CCC. 🤑

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What is the Cash Conversion Cycle?

The Cash Conversion Cycle (CCC) defines a financial KPI. It measures the number of days between the moment a company buys stock and the moment it receives payment from its customers following the sale of this same stock.

At the heart of the operating business, it reflects the time needed to transform operational investments (purchases of products and raw materials, production, storage, etc.) into available cash.

👉 This metric therefore takes into account the time associated with:

• the sale of goods ;
• the actual receipt of payments from customers following these transactions;
• payment of suppliers.

The benefits of the Cash Conversion Cycle in 3 key points

#1 Optimizing cash flow

Mastering this indicator means, above all, better management of your liquidity and cash flow. The aim is to keep this cycle as short as possible.

A shorter CCC means faster recovery of committed cash, and therefore :

• a strengthening of your self-financing capacity;
• reduced recourse to bank credit;
• limiting the risk of cash flow tensions.

#2 Identifying operational friction points

The Cash Conversion Cycle also has the advantage of highlighting certain areas of inefficiency:

• inventory turnover too slow ;
• sales payment times too long ;
• supplier payments too early, etc.

This makes it a highly relevant decision-making tool, enabling you to fine-tune your sales, logistics and accounting policies.

#3 Improving overall profitability

Rigorous management of the Cash Conversion Cycle is not limited to simple accounting optimization. It has a direct impact on your company's financial strategy and investment capacity.

By accelerating the transformation of sales into available cash, you reduce the time between expenditure and collection. The result: less tied-up cash and more resources available to finance your projects... and therefore your growth! 🚀

How to calculate the Cash Conversion Cycle?

KPIs to take into account

Calculating the Cash Conversion Cycle may seem complicated at first, as it involves looking at 3 other KPIs beforehand, directly linked to the company's operational flows:

• DIO (Days of Inventory Outstanding): the average number of days needed to clear inventory;
• DSO (Days Sales Outstanding): measures the number of days it takes your customers to pay you after invoicing;
• DPO (Days Payable Outstanding): the average time you have to pay your suppliers.

The Cash Conversion Cycle formula

As you can see, to obtain your Cash Conversion Cycle, you need to start by calculating the 3 indicators above, by applying the following formulas:

👉 DIO formula

💡The average stock generally corresponds to the average between the initial stock and the final stock over the period.

👉 DSO formula

👉 DPO formula

💡Some professionals use cost of sales instead of purchases in the formula, depending on data availability.

Having done this, it's time to calculate CCC, by applying the following formula:

The result is expressed in number of days.

Example of CCC calculation

To illustrate our point, let's take the example of a company with the following 1-year data:

Here are the preliminary calculations:

• Average stock = (100,000 + 140,000) / 2 = €120,000
• DIO = (120,000 / 800,000) × 365 = 54.75 days, rounded to 55 days
• DSO = (150,000 / 1,200,000) × 365 = 45.63 days, rounded to 46 days
• DPO = (90,000 / 700,000) × 365 = 46.93 days, rounded to 47 days

And finally, here's the Cash Conversion Cycle calculation:

In our example, it therefore takes 54 days from stock purchase to customer collection, once the supplier has been paid.

How to interpret the Cash Conversion Cycle?

Once you've calculated your Cash Conversion Cycle, you'll get a value, either high or low.

🤷‍♂️ By the way, how do you arbitrate the position of this value?

Here, it's all a question of business sector. For example, in the retail sector, because of fast-moving inventories and rapid sales, a typical CCC extends from 10 to 30 days. On the other hand, for a wholesaler (with a fast turnaround, but often negotiated payment terms for business customers), we find an average CCC of 20 to 50 days.

To find out where you stand, find out what is considered a good or bad Cash Conversion Cycle for companies like yours.

That said, here's how to interpret your result. 👇

Is your CCC high?

If your CCC is high by your market's standards, then your company is taking far too long to turn its investments into cash.

This result often reflects:

• inefficient inventory management ;
• excessively long customer payment terms;
• supplier payments that are, on the contrary, too rapid.

In this type of configuration, cash flow remains immobilized, with the attendant risks of stress and increased dependence on external financing.

⚠️ A high CCC is a warning of the risk of blocked cash flow, likely to slow your growth.

Is your CCC low?

A low CCC generally goes hand in hand with a company's good financial health, as it rapidly converts its investments into cash. This gives the company sufficient cash to offset any problems that may arise, and above all to invest in its future!

However, a cycle that is too low can also conceal points of friction, such as supplier lead-times that are too long (beware of the fragility of commercial relations!). As always, balance remains the key.

Tips for optimizing your Cash Conversion Cycle

Play on DIO, DSO and DPO

To optimize their Cash Conversion Cycle, companies can play on the three levers of the indicator: trade receivables, inventory management and financial debts.

💡 Here are a few tips:

• Reduce inventory turnover time. For example:
• regularly analyze your sales to adjust orders;
• use just-in-time whenever possible, and limit slow-moving items;
• use software solutions to better forecast requirements.
  
  
• Reduce the number of days receivables are outstanding, by speeding up collection operations. For example, you can
• shorten lead times by negotiating stricter payment terms when signing contracts;
• set up an automatic alert system to remind customers when payment is due;
• offer early payment discounts or financial incentives.
  
  
• Increase the number of days in debt, by negotiating advantageous terms with your suppliers, such as staggered or deferred payments.

💡 Is your business highly seasonal? Then don't forget to anticipate these variations.

Optimize your internal processes with the right tools

Of course, optimizing your Cash Conversion Cycle also involves precise, ongoing monitoring of your indicators. In this way, you'll have a better idea of how your situation is evolving (especially if your CCC increases), so you can react quickly.

What's more, the administrative and financial delays inherent in your internal organization can reduce your cash flow... without you even realizing it!

Given these facts, it's easy to see why you should use a management tool. And with good reason, this type of software :

• automates repetitive tasks (such as order processing) ;
• simplifies internal validation circuits;
• provides precise visibility of your indicators.

🛠️ Let's take the case of Esker, developed to help SMEs optimize their supplier and customer processes. Thanks to its numerous automations, you can accelerate collections, reduce processing times and deploy a solid collection process. On the supplier side, Esker's functionalities help you to maintain good relations with them, and to be responsive enough to negotiate the best possible terms and conditions. And of course, the solution includes intuitive dashboards that let you monitor your financial indicators in real time.

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Cash Conversion Cycle - FAQ

Can the Cash Conversion Cycle be negative?

Yes, it is possible to have a negative CCC, meaning that you collect cash from your customers before paying your suppliers.

This situation is often considered very favorable, as it frees up cash and improves your working capital.

However, it sometimes reflects strong negotiations with your suppliers or an aggressive policy with your customers. So make sure that such biases don't create tensions in your business relationships!

Is CCC relevant to all company sizes?

Yes, whatever your company's stage of development, CCC monitoring remains a valuable tool:

• for SMEs, it provides a clear view of day-to-day cash management;
• for large companies, it can be used to optimize large volumes of cash flow.

Does the Cash Conversion Cycle evolve with company growth?

It certainly does. In a growth phase, your sales volumes, inventories and receivables increase. This can lengthen the CCC if management doesn't keep up! What's more, you may encounter longer lead times with new customers or suppliers.

We therefore recommend that you regularly reassess your cash conversion cycle and adjust your processes accordingly.

What is the Cash Conversion Ratio and how does it differ from the Cash Conversion Cycle?

The Cash Conversion Ratio measures the efficiency with which a company transforms its net income into cash flow. Unlike CCC, which calculates duration in days, this ratio expresses a percentage or multiple.

Financiers use it to analyze the quality of earnings and the ability to generate real cash from book profits.

Ultimately, the two indicators complement each other to provide an overall view of financial health.

🤩 Now you know more about the Cash Conversion Cycle. Now it's up to you to dominate your CCC, free up your cash... and turn every day into an opportunity!