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Cash conversion cycle

The cash conversion cycle is the number of days it takes a company to run cash through the sales process, from sitting in the bank, through buying inventory, selling that inventory, and receiving the cash from the sale. Shorter is better.

Contents

Expanded Definition

CCC = DIO + DSO - DPO

where
DIO = days inventory outstanding
DSO = days sales outstanding
DPO = days payable outstanding

There are examples of companies having a negative cash conversion cycle. In this case, the company is actually receiving payment for its goods before it had to pay the suppliers of those goods. Dell, in its heyday, was an example of this situation.

DIO

Days inventory outstanding is how many days it takes to sell inventory. Shorter is better. That is, the more quickly a company can sell its inventory, the less time that cash is tied up as inventory sitting on the shelves.

<math>DIO = 365 * \frac{Avg\ inventory}{Cost\ of\ Goods\ Sold}</math>

Inventory balances are found on the balance sheet. Average inventory is the inventory amount at the beginning of the period plus the amount at the end of the period, all divided by two. Cost of goods sold (COGS) is found on the income statement, and is sometimes called "Cost of Sales."

DSO

Days sales outstanding is how many days it takes to collect accounts receivable. Shorter is better. That is, the more quickly a company can collect the cash for the stuff it sells, the more quickly it can put that cash to back work rather than lending it out to its customers (without interest).

<math>DSO = 365 * \frac{Avg\ accounts\ receivables}{Revenue}</math>

Accounts receivable balances (for the average: starting plus ending, all divided by two) are found on the balance sheet. Revenue is found on the income statement.

DPO

Days payables outstanding is how many days it takes the company to pay the bills to its suppliers of inventory. Longer is better. That is, extending payment of accounts payable (usually) acts as an interest-free loan to the company and keeps more cash within the company.

<math>DPO = 365 * \frac{Avg\ accounts\ payable}{COGS}</math>

Accounts payable balances (for the average: starting plus ending, all divided by two) are found on the balance sheet. COGS is found on the income statement.

Example

Here is an example using Costco and the information from the end of its fiscal year, ending Sep. 2, 2007. Amounts are in millions of dollars.

Start End
Inventory $4,561.23 $4,879.47
Accts Receivable $565.37 $762.02
Accts Payable $4,581.40 $5,124.99
Revenue $64,400.16
COGS $56,449.70


<math>CCC = DIO + DSO - DPO</math>

<math>CCC = (365*(\frac{\frac{4,561.23+4,879.47}{2}}{56,449.70})+365*(\frac{\frac{565.37+762.02}{2}}{64,400.16})-365*(\frac{\frac{4,581.40+5,124.99}{2}}{56,449.70}))\ days</math>

<math>CCC = 30.5\ days + 3.8\ days - 31.4\ days = 2.9\ days</math>

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