The Cash Conversion Cycle, also known as the net operating cycle, is how you measure how long it takes for a business to convert the funds spent on inventory and other expenses into a cash flow towards sale and profit for the business. Simply put it is how many days it will take your business to turn investments into your supplies and the production of your goods into cash and profit for the whole business.
The Cash Conversion Cycle is a metric that measures the time it takes a company to pay its bills, handle its accounts payable, and settle all the receivables needed to stay operational.
We use this metric to evaluate how efficient a company’s operations are currently. Increases and decreases are tracked and measured regularly to see if there are changes that really have to be made. You have to keep in mind though that it only applies to specific areas of business that depend on elements like inventory management.
This metric can differ based on what industry your business is in, and the exact nature of your business, but let’s find out.
How is it Computed?
The cash conversion cycle is computed by adding the days that the inventory is outstanding or the daily sale of your goods from your inventory added to the days that your sales remain outstanding, subtracted from the days it takes to settle the outstanding payables. So that would be your CCC=DIO+ DSO-DPO, the DIO being the days your inventory is outstanding, the DSO is the days your inventory remains outstanding minus the days your payables stay outstanding.
What can Computing This Tell You?
Computing the cash conversion cycle can tell you the exact number of days it takes you to complete a whole cycle from receiving your production materials to selling them to a customer. And by doing this you can create accurate predictions for the future of your business. You can estimate when the best time for growth is when the best time for expansion is, and if it is financially responsible for you to increase your inventory based on the demand of the consumers around that are patrons of your business. By piecing your cash conversion cycle together you can make educated guesses towards what the next best steps are for your business without blindly making decisions. Computing for your return of equity and return on assets can be taken from the cash conversion cycle is computed correctly. By identifying your Cash conversion cycle you now have access to more information on your business that you have to take into consideration before making any firm and big decisions for your company.
What does the Cash Conversion Cycle say about the Management?
By accurately computing for your cash conversion cycle, you can determine how effective action plans being rolled out by the operations and management are. You can identify which departments require more assistance, which areas are being mismanaged and it can show you points of weakness that you can improve to create a more efficient overall workflow for your business. It can show which sectors might have management that may need a reassessment or retraining to improve overall performance.
Once you have gotten used to computing for the cash conversion cycle and all the ways this data can be used, you are well on your way to improving the efficiency of your business, improving the overall cash flow, improving management, and how decisions are made in your company. You are well on your way to creating a thriving and successful business with the right data to back up all the success.