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Definition: Cash Conversion Cycle (CCC)
It is a theoretical concept which indicates the amount of time elapsed between the company’s spending cash and recovering it per unit sale of output, etc. It gives a fair idea of the duration the money is tied in the inventory. Thus, a shorter CCC is always preferred. It is usually stated in annual term:
A cash conversion cycle is the time measured in number of days that a company uses to convert its input resources into the cash flows. It includes the time for which inventory is held, time used to collect the collectibles and time used to pay the bills to creditors without bearing any penalty.
Formula for Cash conversion cycle is:
CCC= DIO + DSO - DPO
DIO (Days inventory outstanding) is the days required to sell the entire inventory. A small DIO is preferred as it would reduce the per unit costs associated with holding inventory
DSO (Days Sales Outstanding) is the time required to collect the receivables from the buyers. A small DSO is considered good for the company.
DPO (Days Payable outstanding) is the days that the company uses to pay the payables to its creditors. A longer DPO is wanted by the company as it allows the company to hold the cash for a longer time and hence increases its investment potential.
The CCC is a measure of effectiveness and efficiency of a company to convert its cash into inventory and payables and then into cash through sales and receivables. The CCC of a company alone is not of much use. It is industry specific and when compared with the same of competitors or with the past values of the same of the company, gives information about how the company is faring in the market.
A company M-Corps sells the cricket bats. It purchases the wood from a Kashmiri vendor and pays his dues in 10 days on an average. Then generally, it takes the company 20 days to process the wood, make bats and sell them. It takes the company 5 days to collect the receivables. The Cash Conversion of the company is: