Cash to Cash Cycle is a period of time required by a company to convert inventory into cash. Simply put, for example today a company makes a product and stores it in a warehouse, now the product will only turn into cash, say after 30 days, then that means the company’s cash to cash cycle is 30 days.
Knowing how long the cash to cash cycle is will be useful for the company to determine how much money is needed to run the company’s operations. For example, in the example I gave in the first paragraph, because from today’s production of goods the company will only receive cash in the next 30 days, it means that during the 30-day waiting period the company’s operations must continue, meaning that the company must have capital resilience at least to finance operations for 30 days.
In calculating the cash to cash cycle, the company must also take into account debt, if any. Yes, short-term debt will also affect the length of the cycle of conversion of goods into money. So when summarized, there will be 3 variables that are taken into account in determining the cash to cash cycle, namely:
Short-term debt, which is the average length of time the debt must be paid.
How long the product is kept in inventory, i.e. the average time the product spends in the warehouse.
How long consumers pay for products, is common in the corporate world when consumers buy on credit. Then it must be known how much time the consumer pays on average.
All three variables are calculated with the formula:
Cash to Cash Cycle = How long the product is stored + how long the receivables are paid – average debt payments
For example, a company has short-term debt with an average debt payment of 30 days. Then, the average product stored in the warehouse from the time of production until it is used up by consumers is 50 days, while the average consumer pays receivables within 40 days. So, the company’s cash to cash cycle is 50 + 40 – 30 or 60 days. So it can be concluded, the time required by the company to convert their production into cash is 60 days. So, the company must have capital resilience to finance the company’s operations for at least 60 days so that the company continues to run.
Cash to Cash Cycle (CCC) is a cycle that measures the efficiency of a business in collecting debt. However, there is a small issue that we must consider first how quickly the business decides to pay the amount it owes to the supplier. Accounts payable is a number that is very difficult to settle. Financial considerations alone will encourage management to push the average collection period as high as possible, thereby preserving the cash flow of the business
CCC is a combination of several operating ratios related to receivables, accounts payable, and inventory turnover. AR and inventory are current assets, while AP are liabilities. All of these ratios are found on the balance sheet. Basically, the ratio shows how effectively management uses current assets and liabilities to generate cash. This allows investors to gauge the overall health of the company.
Cash to Cash Cycle (CCC) Elements
To calculate CCC, you will need several items from the financial statements:
Revenue and cost of goods sold (HPP) in the income statement
Inventory at the beginning and end of the period
AR at the beginning and end of the interval
AP at the beginning and end of the interval and
Number of days in the period (year = 365 days, quarter = 90).
Inventory, AR and AP are on two different balance sheets. If the period is a quarter, then use the balance sheet for the quarter in question and then from the previous period. For annual periods, use a balance sheet for the quarter (or year-end) and one from the same period the previous year.
This is because, while the income statement includes everything that happened during a given period, the balance sheet is just a snapshot of what the company looked like at a given point in time. For things like AP, you want the average over the period you’re investigating, which means the AP from the end of the period and beginning is required for calculations.
The cash conversion cycle formula consists of three parts: an open inventory date, an open sale date, and an open maturity date.
Outstanding Inventory Days (DIO): This answers the question of the number of days it will take to sell full inventory. The smaller this number, the better.
DIO = Average distance / COG per day
Average inventory = (beginning inventory + ending inventory) / 2
Sales Days of Excellence (DSO): This is the number of days it takes to acquire and connect AR. Even though cash-only sales have a zero DSO, the company’s extended credit is still being used, so the number will be positive. Again, the smaller the number the better.
DSO = AR / Average Sales per Day
AR = mean (start of AR + end of AR) / 2
Outstanding Due Date (DPO): This relates to the payment of company or AP bills. If this can be maximized, companies hold cash longer, maximizing investment potential; therefore a longer DPO is better.
DPO = Average AP/COG per day
Average AP = (initial AP + late AP) / 2
Note that DIO, DSO, and DPO are all paired with the appropriate term in the income statement, or COGS. Inventory and AP are paired with COGS, while AR is paired with revenue.
Cash to Cash Cycle (CCC) or Cash Conversion Cycle is the time span between a company paying to a supplier and receiving money from a customer (buyer). Included in this CCC calculation are all inventory owned by the company or from cash inflows originating from product sales. CCC is used by companies to measure the amount of ongoing operational financing, by knowing the amount of cash that comes out, the company can determine the budget as needed. In essence, CCC is the approximate time when the investment in the business turns into cash.
Cash to Cash Cycle is one part of determining the evaluation of the company’s balance sheet, namely capital adequacy and CCC is used to manage 2 important assets, namely receivables and inventory. This CCC generally has a formula that can be used to measure the amount of time (usually in days) which is then used by the company to convert its resource inputs into cash. That is why the Cash to Cash Cycle is used as the key in determining or estimating financing needs.
