Because "time is money", get your Cash Conversion Cycle under control

A balanced cash position is undoubtedly a sine qua non for a company's success and long-term future. Successful organisations are those that have made it part of their daily routine to monitor various financial indicators: net profit, 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 for investments to be converted 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, wouldn't you say?

Well, the Cash Conversion Cycle is our topic for today. On the programme: 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 is used to measure 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 activity, it reflects the time required 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 usefulness of the Cash Conversion Cycle in 3 key points

#1 Optimising cash flow

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

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

• a strengthening of your self-financing capacity ;
• less reliance on 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 that are 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 optimisation. It has a direct impact on your company's financial strategy and investment capacity.

By speeding up the conversion 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 do you calculate the Cash Conversion Cycle?

The KPIs to take into account

Calculating the Cash Conversion Cycle sometimes seems 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): this is the average number of days needed to clear inventory;
• DSO (Days Sales Outstanding): this measures the number of days it takes your customers to pay you after invoicing;
• DPO (Days Payable Outstanding): this is 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 formulae:

👉 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 the cost of sales instead of purchases in the formula, depending on the availability of data.

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

The result is expressed as a 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 to be made:

• 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

Finally, here is the calculation of the Cash Conversion Cycle:

In our example, 54 days elapsed between the purchase of stock and collection from the customer, once the supplier had been paid.

How do you interpret the Cash Conversion Cycle?

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

🤷‍♂️ How do you arbitrate the position of this value?

Here, it's all a question of business sector. For example, in the retail trade, because of fast-moving stocks 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 convert its investments into cash.

This result often reflects:

• inefficient stock management ;
• excessively long customer payment terms;
• supplier payments that are, on the other hand, too fast.

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

⚠️ A high CCC is therefore a warning of the risk of blocked cash flow, which could 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. The company then has 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 relationships!). As always, balance remains the key.

A few ways to optimise your Cash Conversion Cycle

Play on the DIO, DSO and DPO

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

💡 Here are a few tips:

• Reduce stock turnover time. For example:
• regularly analyse your sales to adjust orders ;
• favour just-in-time whenever possible, and limit slow-moving items;
• Use software solutions to better forecast requirements.
  
  
• Reduce the number of days your receivables are outstanding by speeding up collection operations. For example, you can
• shorten lead times by negotiating stricter payment terms when contracts are signed;
• set up an automatic alert system to remind customers when the due date has passed;
• offer discounts for early payment 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.

Optimise your internal processes using the right tools

Of course, optimising your Cash Conversion Cycle also involves precise, ongoing monitoring of your indicators. This will give you a better idea of how your situation is evolving (especially if your CCC increases) so that you can react quickly.

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

Given all this, 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 optimise 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 be responsive enough to negotiate the best possible terms and conditions. Of course, the solution includes intuitive dashboards that allow you to 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, which means that you collect cash from your customers before paying your suppliers.

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

However, it sometimes reflects strong negotiations with your suppliers or an aggressive policy towards your customers. So make sure that such biases do not create tensions in your commercial relations!

Is the CCC relevant for all sizes of company?

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 optimise large volumes of cash flows.

Does the Cash Conversion Cycle change as a company grows?

It certainly does. During 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 profit into cash flow. Unlike the CCC, which calculates the duration in days, this ratio expresses a percentage or a multiple.

Financiers use it to analyse 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.

🤩 You now 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!