Have you ever used a cash conversion cycle calculator? If you want to analyze a company, this smart tool will let you know how long it takes for an operating cycle of a business to get completed. You can learn how to use it in this article.
Besides, you will find out how to calculate the cash conversion cycle (CCC) by hand and what components this formula includes. You can also learn about a negative as well as increasing or decreasing CCC. We will provide a few examples to help you understand how it works in real-life situations. Let’s get straight to the point!
Cash Conversion Cycle: What Is That?
Before moving further, let’s see what the cash conversion cycle (also known as the Cash Cycle or Net Operating Cycle) represents. Basically, this metric tells how many days are needed to convert investment in inventory. It also shows how long it takes for other resources to get converted into cash flow. The time required for selling inventory, paying bills, and collecting receivables is also included.
If you plan to invest some money in sales and production, the cash conversion cycle (CCC) can help you find out how long it will be tied up (unavailable) before you manage to convert it into cash. This is very helpful for investors and businesses.
From the raw material acquisition (the initial stage) to service or product delivery (the final stage), the cash conversion cycle comprises the entire business process. In addition to the operational tasks, it covers things like getting supplier credit and providing it to customers.
The cash conversion cycle is a quantitative measure that plays an important role in evaluating the business efficiency for both a company’s management and operations. If the values are constant or tend to decrease over time, this means a business is efficient. On the other hand, if the CCC constantly increases, then you need to consider other factors when investigating and analyzing a company.
Key Components of Cash Conversion Cycle
In the financial accounts, you can find everything that matters to the business operating cycle. Take a look at the balance sheet. Everything is shown in the form of money items. Read on to find out what it includes.
Accounts payables
It’s a current liability item representing money owed to suppliers. Accounts payable is a very important area of finance because it deals with the company’s financial obligations to suppliers. It is usually paid in cash. The process begins when the company receives an invoice from its supplier for goods or services. Then the company should record this transaction in its books. The records include the date of receipt of goods or services, the amount owed to the supplier, description of what was purchased, etc.
Accounts receivables
It is the process of company collecting money owed to them by their customers. The process of accounts receivables involves two steps:
- The company sends an invoice to its customer to request payment for goods or services provided on credit;
- The customer pays the invoice by writing out a check and sending it back to the supplier.
Accounts receivable is a company’s balance sheet liability. It is the amount that a company owes its suppliers, trade creditors, and other parties for goods or services provided on credit. Accounts receivable are considered current assets because they are due within one year or within the normal operating cycle of the business, whichever is longer.
Inventories
Inventories are considered to be a current asset because they are so easily liquidated. They are an important component of a company’s financial practices. They cover every cost of the materials (both end products and raw materials) that belong to the core business. The major function of inventories is to provide a buffer between supply and demand by storing raw materials, work-in-progress, and finished goods until they can be sold.
The cash conversion cycle is actually defined by these 3 components and their relations. This includes everything from posterior processing and material acquisition to receiving payments from clients and supplier payments. Once the company reaches the final stage, the cycle begins again.
CCC Formula: How to Calculate Cash Conversion Cycle
To calculate CCC, use the following formulas:
Avg_inv = (Beg_inv + End_inv) / 2
Avg_acc_re = (Beg_acc_re + End_acc_re) / 2
Avg_acc_pay = (Beg_acc_pay + End_acc_pay) / 2CCC = Avg_acc_re / (rev / t) + Avg_inv / (COGS / t) – Avg_acc_pay / (COGS / t)
Where,
CCC = cash conversion cycle
Avg_acc_re = average accounts receivables
Beg_acc_re = beginning accounts receivables
End_acc_re = end accounts receivables
Avg_acc_pay = average accounts payable
Beg_acc_pay = beginning accounts payable
End_acc_pay = end accounts payable
Avg_inv = average inventory
Beg_inv = beginning inventory
End_inv = end inventory
COGS = cost of goods sold (direct production costs)
t = period of analysis (quarterly or yearly)
rev = total revenues
Example
Do you want to try out our calculator? Use the following values and try to calculate the cash conversion cycle.
- Beginning of Inventory: 44,269
- End of Inventory: 44,435
First, you need to calculate the average inventory. Avg_inv = (44,269 + 44,435) / 2 = 44,352
- Beginning accounts receivables: 6,283
- End accounts receivables: 6,284
Next, you should calculate average accounts receivables. Avg_acc_re = (6,283 + 6,284) / 2 = 6,283.50
- Beginning accounts payable: 47,070
- End accounts payable: 46,973
Now you should calculate the average accounts payable. Avg_acc_pay = (47,070 + 46,973) / 2 = 47,021.5
- Total Revenues: $523,964
- Costs of Goods Sold (COGS): $394,605
- Period of analysis (t): 365 days
Finally, you will be able to calculate the cash conversion cycle.
CCC = Avg_acc_re / (rev / t) + Avg_inv / (COGS / t) – Avg_acc_pay / (COGS / t) = 1.91
NOTE: As stated above, check the income statement and balance sheet when calculating the cash conversion cycle to find the info you’re looking for. The period of analysis is 365 days when using annual reports. Alternatively, you can use quarterly information – then the period of analysis would be 90 days.