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Monitoring the cycle is crucial for small to mid-sized businesses that want to increase cash flow and grow — especially during inflationary periods.
The cash conversion cycle (CCC) is a metric that indicates the number of days it takes a business to turn cash spent on inventory into cash earned from sales. The goal is generally to minimize CCC to increase the business’s cash flow. A business’s ideal CCC number depends on its particular industry and goals. Many businesses compare cash conversion cycles for similar companies as a baseline, while others may simply monitor their CCC for changes over time.
Here’s how to calculate the cash conversion cycle:
DIO + DSO – DPO = CCC
This formula uses three other metrics:
To shorten a cycle, a business must turn over inventory faster, collect invoice payments faster and/or take more time to pay bills. There are a few key ways to do this. Decreasing DIO usually involves long-term strategies such as better marketing and inventory management, while DSO and DPO offer more immediate opportunities to minimize CCC. For example, businesses can decrease DSO by invoicing promptly or offering buyers early payment incentives through programs such as C2FO’s Early Payment platform. Businesses can also increase DPO by paying bills on their due date and no earlier.
Businesses serving other businesses often invoice for goods once they are delivered and wait for the agreed-upon payment term to mature before receiving payment. However, some businesses may receive payment on delivery or even prepayment for the goods provided. In the latter case, the business most likely experiences a negative cash conversion cycle because inventory is converted into cash before the inventory is acquired by the customer.
The cash conversion cycle is an important consideration for businesses that acquire, store and sell physical inventory. Financial analysts and investors often look at a business’s cash conversion cycle alongside other metrics to assess its financial standing, risk and operational efficiency.
This metric is particularly valuable for small to mid-sized businesses, especially those with an inconsistent cash flow or fixed working capital positions. Decreasing the cash conversion cycle allows a business to improve cash flow and access the working capital needed to make growth investments. Analyzing CCC can help businesses pinpoint the cause of a reduced cash flow, such as lengthy invoice payment terms.
Monitoring the cycle is also crucial during inflationary periods when raw material and inventory costs can rise significantly. This is because as inflation increases, a business’s cash loses purchasing power over time. If a business can turn its inventory into cash next week, that cash will have more value than it will in three weeks when new inventory costs are inevitably higher.
Small to mid-sized suppliers in this environment can expect to see cash conversion cycles rise as buyers extend accounts payable timelines to preserve their own working capital. During inflation, a higher CCC can quickly erode a business’s cash flow and revenue unless it takes proactive steps — such as increasing prices or using an early payment program to access working capital.
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