Cash Conversion Cycle (CCC) sounds like the kind of thing a “finance guy” says to convey a level of pith when you know it’s merely status signaling amongst peers and decision makers. It tends to be bandied about in conjunction with terms like “vendor terms” or “working capital”. Like most of finance jargon, it describes a concept with which your already intimately familiar. In this case, the time it takes to turn money for stuff and people into money for your operation.

To break this town, Cash Conversion Cycle (CCC) is calculated by the following formula:

Days Inventory Outstanding (DIO)   * Average days it takes to turn investment in raw materials into sales

+ Days Sales Outstanding (DSO)          * Average days it takes to turn sales into cash

–  Days Payables Outstanding (DPO)   * Average days takes to pay bills

Cash Conversion Cycle (CCC)

For your edification, here are the formulas for DIO, DSO, and DPO

DSO = (Accounts Receivable/Credit Sales) x Number of days in the period of Credit Sales

For Example:

Credit Sales = 1,200,000

Days = 365

Accounts Receivable = 200,000

Or a DSO of approximately 61 days

DIO = (Average Inventory / Cost of Sales) x Number of days in the period of Cost of Sales

For Example:

Cost of Sales = 800,000

Days = 365

Beginning Inventory = 80,000

Ending Inventory = 90,000

Average Inventory = (80,000 + 90,000)/2 or 85,000

Or a DSO of approximately 39 days

DPO = (Accounts Payable / Cost of Sales) x Number of days in the period of Cost of Sales

For Example:

Cost of Sales = 800,000

Days = 365

Accounts Payable = 40,000

Or a DPO of approximately 18 days

Now, let’s apply the original formula for Cash Conversion Cycle to the above example:

DSO = 61 days

DIO = 39 days

DPO = 18 days

And our Cash Conversion Cycle is 82 days.

So why does this matter? Because it takes you almost a whole quarter to turn spending into money.  Because your vendors want to get paid in 18 days for raw materials (according to your DPO) and it takes you 100 days (DSO + DIO) to turn it into cash. Basically, you’ve got to cover cash for 2 ½ months with your own capital or from somewhere else.

For some, this is a normal cycle time. If you make a widget, this probably isn’t too far off. If you’re in software, it could be negative. (no inventory, get paid up front, and you pay bills in 25 days) The reason this metric is so important to “finance folk” is that it communicates much about a business’ health, risk, and capital structure. For you, it is likely a working capital question. Questions like, “am I asking for enough with this line of credit?” or “Can I cover new inventory with current sales and still pay my staff?”.  While the concept isn’t tremendously complicated, the substance of what it communicates is nuanced and informs tactics in a real way.