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  • Home
  • About
  • Podcast
    • Summaries
    • Articles
  • Invoice Finance
    • Basics
      • What is Invoice Finance?
      • What is Reverse Factoring?
      • What are Trade Receivables?
      • What is the Cash Conversion Cycle?
      • What is Days Inventory Outstanding?
      • What is Days Sales Outstanding?
      • What is Days Payable Outstanding?
    • Advanced
      • Invoice Validation and Fraud Detection
      • Reasons Why Invoice Finance is Better than a Bank Loan
      • How to Choose the Right Factoring Firm for Your Business
      • A Closer Look at Factoring Agreements
      • What is Trade Receivables Securitisation?
      • Breakdown of the Costs for Factoring
    • Factoring
      • Why Companies Use Invoice Factoring
      • What Companies are Suitable for Invoice Factoring?
      • Factoring and Invoice Discounting
      • How Factoring Works
      • Asset Based Lending
      • Is Factoring Right for Your Company?
      • Accounting for Factoring
      • How a Company Enters into a Factoring Agreement
      • The Costs Involved in Factoring
      • Changing Factoring Company
      • The Relationship Between the Factoring Company and the Debtor
      • Legal Aspects of a Factoring Company Pursuing Payment Through the Courts
      • Factoring in the Construction Industry
    • Fraud
      • Types of Invoice Fraud
      • How to Combat Invoice Fraud
    • E-Invoicing
      • Legal Status of Electronic Invoicing
      • The Benefits of E-Invoicing
      • Implementing an E-Invoice System
      • E-Invoicing Adoption in Mexico and The Rest of the World
  • Brokers
    • UK Brokerage Firms
  • Factoring Firms
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      • UK
      • France
      • Germany
      • Italy
      • Spain
      • Holland
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    • UK Fintech
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      • Enhancing Fintech Interoperability: Digitalizing Trade Documents for Efficiency and Security
      • The 7 Types of AI and Their Implications for the Future
      • Transforming Trade Finance: The Role of AI
      • The Different Programming Languages Used in Fintech Companies and Financial Institutions
      • UK and US Authorities Intervene in AI Sector
      • Web3 Applications and the Future of Trade Finance
      • What is Web 3?
      • What Can Fintech do for You?
      • What is Fintech?
      • Tokenisation of Finance
      • Payment Services in the Invoice Finance Sector
      • What is ChatGPT and Why the Fuss?
  • Rating Agencies
  • Securitisation
    • Deal Arrangers
    • Book Runners
    • Articles
      • The Roles of Deal Arrangers and Book Runners in Securitization
      • What is Trade Receivables Securitisation?
      • The Appeal of Trade Receivables Securitisation
      • Risk Mitigation for Trade Receivables Securitisation
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      • A Guide to Accounts Receivable Purchase Agreements and Invoice Discounting Agreements
      • The Challenges of KYC and AML Checks
      • What is The Model Law on Electronic Transferable Records (MLETR)?
      • Snapshot of Factoring Legal Schemes in England and Wales
      • How are UK Factoring Firms Regulated?
      • What is ISO20022 and Why is it Important?
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      • Financial Crisis or Not?
      • Credit Suisse Bailout
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      • Eligibility Requirements for Capital Relief by Using Credit Insurance
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      • How the War in Ukraine Affects the Price of Credit Insurance for Trade Finance
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Home Invoice Finance

What is the Cash Conversion Cycle?

John Goodden by John Goodden
February 8, 2023
in Invoice Finance
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What is the Cash Conversion Cycle?
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Download file | Play in new window | Duration: 5:24 | Recorded on September 6, 2022

The cash conversion cycle is a key indicator for a company to show how quickly a company converts cash into inventory and then converts that inventory back into cash via sales. The faster a company makes a product and sells it, the more efficient that company is. The ideal situation is to have cash tied up in accounts receivable and inventory for as little time as possible. Moreover, if the time allowed for paying for materials and supplies (days payable outstanding or DPO) is increased then cash flow is further enhanced. It is the ideal situation for a company to quickly make and sell things and be able to delay payment for supplies. It is the ideal situation where cash flow ceases to be a problem.

How to Calculate the Cash Conversion Cycle

First a note on the terms used:

CCC = Cash Conversion Cycle

DIO = Days Inventory Outstanding; it measures the average number of days that a company holds inventory prior to a sale.

DSO = Days Sales Outstanding; it measures the number of days, on average, that a company takes to collect its accounts receivable.

DPO = Days Payable Outstanding; it measures, on average, how many days a company is taking to pay its suppliers.

The formula is as follows:

CCC = DIO + DSO – DPO

DIO is calculated by average inventory value/cost of goods sold x number of days

DSO is calculated by sum of accounts receivable (unpaid invoices from customers) x number of days/total credit sales

DPO is calculated by sum of accounts payable (what the company owes) x number of days/cost of goods sold.

So, if the DIO is 40 days, the DSO is 30 days and the DPO is 40 days

CCC = 40+30-40 = 30 days

All Important Context

There are a number of key factors to consider:

  • Comparing the CCC of a company that makes aeroplanes with the CCC of a company manufacturing cars is not helpful. It takes much longer to build a plane than a car. More useful is to compare company CCCs in the same sector.
  • A company that has managed to negotiate payment terms with suppliers so that they have a high DPO might create a low or even negative CCC score. However, that company might gain a reputation in its sector for being a slow payer. Thus, causing reputational damage. It might even deter some suppliers from wanting to do business with a company that takes a long time to pay up.

Further Analysis

The cash conversion cycle identifies three financial levers: DIO, DSO and DPO. Change any of these three numbers and the CCC is altered.

Thus, a company should look at how to speed up production and how to sell its products faster. This could be achieved by scrutinising the production process; by investing in better technology to increase productivity; and by reducing waste in materials. So, DIO improvement involves improvements in both production systems and marketing.

DSO is a reflection of the amount of time it takes for customers to pay for products. Clearly, waiting 90 days for an invoice to be paid means a company has its money tied up when it could be put to better use. One way to reduce DSO is to use a factoring company that will release cash quickly back into the cash conversion cycle.

As has been mentioned, DPO can be a bone of contention. A big company that uses its size to bully smaller companies supplying them to accept long delays in payment is not going to be popular. However, a company can work with its suppliers, perhaps by participating in an early payment scheme such as invoice discounting. In this system a factoring company pays the supplier immediately and gives the buyer a longer period of time to settle the account.

In Summary

When a company board meets it needs data to scrutinise; it needs numbers; it needs comparisons. The cash conversion cycle provides a number. The lower the number the better. A low number means cash flow is good, and the danger of running out of money is minimised.

The formula for CCC also highlights the possible areas where improvements can be made. Good analytics just as much as big ideas can keep a company profitable.

Tags: cash conversion cycleDays Inventory Outstandingdays payable outstandingdays sales outstanding
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  • Home
  • About
  • Podcast
    • Summaries
    • Articles
  • Invoice Finance
    • Basics
      • What is Invoice Finance?
      • What is Reverse Factoring?
      • What are Trade Receivables?
      • What is the Cash Conversion Cycle?
      • What is Days Inventory Outstanding?
      • What is Days Sales Outstanding?
      • What is Days Payable Outstanding?
    • Advanced
      • Invoice Validation and Fraud Detection
      • Reasons Why Invoice Finance is Better than a Bank Loan
      • How to Choose the Right Factoring Firm for Your Business
      • A Closer Look at Factoring Agreements
      • What is Trade Receivables Securitisation?
      • Breakdown of the Costs for Factoring
    • Factoring
      • Why Companies Use Invoice Factoring
      • What Companies are Suitable for Invoice Factoring?
      • Factoring and Invoice Discounting
      • How Factoring Works
      • Asset Based Lending
      • Is Factoring Right for Your Company?
      • Accounting for Factoring
      • How a Company Enters into a Factoring Agreement
      • The Costs Involved in Factoring
      • Changing Factoring Company
      • The Relationship Between the Factoring Company and the Debtor
      • Legal Aspects of a Factoring Company Pursuing Payment Through the Courts
      • Factoring in the Construction Industry
    • Fraud
      • Types of Invoice Fraud
      • How to Combat Invoice Fraud
    • E-Invoicing
      • Legal Status of Electronic Invoicing
      • The Benefits of E-Invoicing
      • Implementing an E-Invoice System
      • E-Invoicing Adoption in Mexico and The Rest of the World
  • Brokers
    • UK Brokerage Firms
  • Factoring Firms
    • Europe
      • UK
      • France
      • Germany
      • Italy
      • Spain
      • Holland
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      • USA
      • Canada
    • Australasia
      • Australia
      • New Zealand
  • Hi-Tech
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    • UK Fintech
    • Articles
      • Enhancing Fintech Interoperability: Digitalizing Trade Documents for Efficiency and Security
      • The 7 Types of AI and Their Implications for the Future
      • Transforming Trade Finance: The Role of AI
      • The Different Programming Languages Used in Fintech Companies and Financial Institutions
      • UK and US Authorities Intervene in AI Sector
      • Web3 Applications and the Future of Trade Finance
      • What is Web 3?
      • What Can Fintech do for You?
      • What is Fintech?
      • Tokenisation of Finance
      • Payment Services in the Invoice Finance Sector
      • What is ChatGPT and Why the Fuss?
  • Rating Agencies
  • Securitisation
    • Deal Arrangers
    • Book Runners
    • Articles
      • The Roles of Deal Arrangers and Book Runners in Securitization
      • What is Trade Receivables Securitisation?
      • The Appeal of Trade Receivables Securitisation
      • Risk Mitigation for Trade Receivables Securitisation
  • Legal
    • Law Firms
    • Articles
      • A Guide to Accounts Receivable Purchase Agreements and Invoice Discounting Agreements
      • The Challenges of KYC and AML Checks
      • What is The Model Law on Electronic Transferable Records (MLETR)?
      • Snapshot of Factoring Legal Schemes in England and Wales
      • How are UK Factoring Firms Regulated?
      • What is ISO20022 and Why is it Important?
  • Rates
  • Economy
    • Economic Indicators
    • Articles
      • The Collapse of the Russian Rouble: An Historical Analysis and Current Implications
      • The Current State of the UK Economy
      • Economic Forecast for the UK in 2023
      • Economic News for 2022
      • Financial Crisis or Not?
      • Credit Suisse Bailout
  • Credit Insurers
    • Credit Insurers
    • Articles
      • Credit Insurance Legal Aspects
      • Credit Insurance in Trade Receivables Financing
      • The Benefits of Credit Insurance in Invoice Finance
      • Eligibility Requirements for Capital Relief by Using Credit Insurance
      • What are Export Credits and Country Risk Classifications?
      • How the War in Ukraine Affects the Price of Credit Insurance for Trade Finance
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    • UK Passes Financial Services and Markets Act 2023
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    • How will MiCA (Markets in Crypto Assets) Regulation Affect Trade Finance and the Banking System?
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    • How DeFi Fulfils the Functions of Finance
    • Taxonomy of Crypto Assets
    • Crypto Currencies
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    • Interview with Crossflow
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