A financial indicator known as the Cash Conversion Cycle (CCC) gauges a company's ability to convert inventory investments into cash from sales.
There are three key components to the CCC which are days inventory outstanding (DIO), days sales outstanding (DSO), days payables outstanding (DPO).
A financial indicator known as the Cash Conversion Cycle (CCC) gauges a company's ability to convert inventory investments into cash from sales. It basically follows the path of cash, from the time a business purchases raw supplies until it gathers consumer payments.
There are three key components to the CCC:
Days Inventory Outstanding (DIO): The number of days a company takes to sell its inventory.
Days Sales Outstanding (DSO): The average time it takes to collect payments from customers.
Days Payables Outstanding (DPO): The number of days a company takes to pay its suppliers.
CCC = DIO+DSO−DPO
For liquidity, a shorter CCC indicates a corporation recovers cash more quickly. A lengthier CCC could point to problems in sales, inventory control, or collecting.
Assume a corporation spends 40 days selling its merchandise (DIO), 30 days gathering consumer payments (DSO), and 35 days paying its suppliers (DPO).
CCC=40+30−35=35 days.
The corporation thus needs 35 days to turn its inventory investment into cash.
While a high CCC could point to delays in sales or collections, so affecting liquidity, a low CCC suggests good cash flow management. Companies want to maximize their CCC to keep their financial situation and operations free from disturbance.