Cash Conversion Cycle

The cash conversion cycle (CCC) is one of several measures of management effectiveness. It measures how fast a company can convert cash on hand into even more cash on hand. The CCC does this by following the cash as it is first converted into inventory and accounts payable, through sales and accounts receivable, and then back into cash. Generally, the lower this number is, the better for the company.

CCC is calculated as DIO + DSO – DPO; which makes perfect sense, as your company must invest cash into both inventory and accounts receivable, but conserves cash when it is financed by your suppliers with accounts payable.

Although it should be combined with other metrics (such as return on equity and return on assets), it can be especially useful for comparing close competitors, because the company with the lowest CCC is often the one with better management.

From slightly different perspective, CCC measures how long a firm will be deprived of cash if it increases its investment in current assets (inventory and A/R) in order to increase its sales. Therefore, it thus becomes a measure of the liquidity risk caused by its growth.

However, shortening the CCC creates its own risks: while a firm could theoretically achieve a negative CCC by collecting from customers before paying suppliers, a policy of strict collections and lax payments is not always sustainable. Or even possible.