How to Improve Your Cash Conversion

Knowing your business’ cash conversion cycle (CCC) is something your business should know if you operate a retail business or one that maintains inventory and want to do a better job of managing cash flow. This is an important metric that you need to understand and manage. In this article you will know everything you need to know about what cash conversion means and how it can help your business.

What Is a Cash Conversion Cycle?

Your CCC is the time it takes to convert resources into cash flows. In an ideal world, this cycle should be as short as possible so that your money is not tied up in inventory or accounts receive for too long because it can result in cash flow problems.

There are many things that impact the duration of the CCC. Businesses that have negotiated longer payment terms with their suppliers will have a shorter CCC since cash does not have to be paid out as fast. If you extend trade credit terms to your customers your CCC will be extended since they have longer to pay you. Slow sales and economic downturns can increase your CCC.

Why Does Your Cash Conversion Cycle Matter?

The CCC is useful to understand your business’ cash efficiency and overall financial health. The quicker you can convert cash into a dollar cash flow, you will shorten the window for reinvest that cash back into the business. If your business has a long CCC, cash flow can cause problems and you might need to have working capital to fund both your operations and growth.

The Difference Between Cash Conversion Cycle and Operating Cycle

Your business’ operating cycle is similar to its CCC because both of measure how effective you are at managing cash. The two terms are often used interchangeably, but they are different. The CDC measures the days it takes to convert resources to cash, the operating cycle is more specific because it represents the time it takes from the outlay of cash to get inventory to receiving payment against those sales from your customers. The operating cycle is, therefore, an indicator of your operating efficiency, while the CCC provides insight into how you are managing cash flow.

How Do You Calculate Your Cash Conversion Cycle?

Calculating the CCC of your business is an important exercise that supports any cash flow analysis and is an indicator of how your company is managing your working capital. To calculate your CCC, you need to know the following:

  • Revenue and COGS.
  • Inventory at the beginning and end of the quarter.
  • Accounts receivable and payable at the beginning and end of the quarter.
  • Number of days in the period to be calculated.

What the Numbers Mean

When you have a positive CCC, there are several meanings which include the following:

  • You are smart about your inventory.
  • You collect what you are owed.
  • You pay your vendors on time.
  • Lenders love to see a positive CC because it shows you collect most of your profits.

Note that it does not mean you are in the clear by having a positive CCC. It is an important indicator that you do need to keep your eye on though because there are other factors that indicate the health of your business too.

Strategies for Improving Cash Flow and Cash Conversion Cycle

To improve your CCC you will need to follow cash flow management techniques such as how long it takes you to pay your suppliers, expediting the accounts receivable process and reducing expenses and improving revenues when possible.

It is important to consider the financial strategies available to you that can help remedy some of the causes of lengthy cash conversions cycles and cash flow issues.