The cash conversion cycle calculates the flow of cash and helps in measuring the time taken by a company to convert its inventory investment and other resource inputs into cash.

The cash cycle can be categorized into three different parts. The first part of the cycle shows the current report of inventory level and how much time the company will have to spend to sell this inventory. Days inventory outstanding calculation is used to calculate this stage.

The second stage of deals with current sales and the time spent to bring in the cash from these sales. For this, the days sales outstanding calculation is used.

The third stage deals in current outstanding payables. Simply put, this shows how much a company owes its current vendors for inventory and goods purchases and when the company needs to pay off its vendors. This calculation is done through days payables outstanding calculation.

Formula to calculate Cash Conversion Cycle

The following calculations need to be made before the Cash Conversion Cycle can be calculated.

The calculation of cash conversion cycle is done by summation of days inventory outstanding to the days sales outstanding and subtraction of the days payable outstanding.

Example

Vovno is a retail shop that deals in outdoor and fishing equipment. Vovno purchases its inventory from one main vendor and pays its accounts within 10 days in so as to get a purchase discount. Vovno has a fairly high inventory turnover ratio and is likely to vring in cash from accounts receivable from his customer within 30 days on an average.

Vovno’s days calculations are as follows:

DIO (days inventory outstanding): 15 days

DSO (days sales outstanding): 2 days

DPO (days payable outstanding): 12 days

The calculation of Cash Conversion Cycle can be done as:

CCC = 15 days + 2 days – 12 days

CCC = 5 days

The above figure clearly shows Vovno’s cash conversion cycle is 5 days. This means it takes Vovno 5 days from paying for its inventory to get in the cash from its sale. So, Vovno needs to be put into comparison with other companies in its industry over time to check whether its cycle is reasonable or needs some improvement.