Cash Conversion Cycle

What is the Cash Conversion Cycle?

Cash conversion cycle, also known as Net Operating Cycle, measures the time which the company takes for converting its inventory and other inputs into the cash and considers the time required for selling the inventory, time required for collecting receivables, and the time company gets for paying its bills

We have Amazon and Ford’s chart of the Cash Conversion Cycle (CCC) in the above chart. And from this chart, it’s clear that Ford Cash Cycle is 261 days, while Amazon’s Cash Cycle is negative! Which company is doing better? Does it matter for a company?  If it matters, how do we calculate it?

If you look at the term, you would understand that it has everything to do with turning cash into something else and how much time it takes to turn that “something else” into cash again. In simple terms, it means how long cash is tied up in inventory before the inventory is sold and cash is collected from the customers.

Think about a simple example to understand this. Suppose you go to the market and buy gold and keep it until you can sell that again in the market and receive cash. The time since when you go to the market and collect gold to the time you receive the cash to sell the gold again is called the cash conversion cycle.

It is one of the best ways to check the sales efficiency of the company. It helps the firm know how quickly they can buy, sell, and receive cash. It is also called a cash cycle.

Amazon Ford Cash Conversion Cycle

Cash Conversion Cycle Formula

Let’s have a look at the formula, and then we will explain the formula in detail.

Cash Conversion cycle Formula= Days Inventory OutstandingDays Inventory OutstandingDays Payable Outstanding (DPO) is the average number of days taken by a business to settle their payable accounts. DPO basically indicates the credit terms of a business with its creditors. read more (DIO) + Days Sales Outstanding (DSO) – Days Payable Outstanding (DPO)

Now let’s understand each of them.

DIO stands for Days Inventory OutstandingDays Inventory OutstandingDays Inventory Outstanding refers to the financial ratio that calculates the average number of days of inventory held by the company before selling it to the customers, providing a clear picture of the cost of holding and potential reasons for the delay in the inventory sale.read more. If we break days inventory outstanding further, we would need to divide inventory by cost of sales and multiply by 365 days.

Days Inventory Outstanding (DIO) = Inventory / Cost of Sales * 365

Days Inventory Outstanding signifies the total number of days taken for the company to convert the inventory into the finished product and complete the sales process. (also look at Inventory Valuation)

Later in the example section, we will take DIO and illustrate it with an example.

DSO stands for Days Sales OutstandingDays Sales OutstandingDays sales outstanding portrays the company's efficiency to recover its credit sales bills from the debtors. The number of days debtors took to make the payment is computed by multiplying the fraction of accounts receivables to net credit sales with 365 days.read more. How would we calculate it? Here’s how. Take accounts receivableAccounts ReceivableAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet.read more. Divide it by net credit sales. And then multiply by 365 days.

Days Sales Outstanding (DSO) = Accounts Receivable / Net Credit Sales * 365

We will see an example of DSO in the example section.

DPO stands for Days Payable OutstandingDays Payable OutstandingDays Payable Outstanding (DPO) is the average number of days taken by a business to settle their payable accounts. DPO basically indicates the credit terms of a business with its creditors. read more. We need to calculate Days Payable Outstanding by taking accounts payable into account, and then we need to divide it by Cost of Sales and then multiply it with 365 days.

Days Sales Oustanding signifies the number of days taken to convert the Accounts Receivables to Cash. You can think of this as the credit periodCredit PeriodCredit period refers to the duration of time that a seller gives the buyer to pay off the amount of the product that he or she purchased from the seller. It consists of three components - credit analysis, credit/sales terms and collection policy.read more given to your clients.

Days Payable Outstanding (DPO) = Accounts Payable / Cost of Sales * 365

Now you may wonder why we are adding DIO and DSO and deducting DPO. Here’s why. In the case of DIO and DSO, the firm would about get an inflow of cash, whereas, in the case of DPO, the firm needs to pay out cash.

Days Payable Oustanding is the credit period that you get from your suppliers.

Interpretation of the Cash Conversion Cycle

This ratio explains that how much time it takes for a firm to receive cash from customers after it has invested into purchasing the inventory. When the inventory is purchased, the cash is not immediately paid. That means the purchase is made on credit, which gives the firm some time to market the inventory to the customers. During this time, the firm makes sales, but don’t receive the cash yet.

Then the day comes when the firm needs to pay for the purchase it has made earlier. And after some time, the firm receives the cash from the customers on the due date.

Now, it may seem a bit confusing, but if we use a date, it would be easier to understand. Let’s say that the due date for payment for the purchase is 1st April. And the date of receiving the cash from customers is on 15th April. That means the Cash Cycle would be the difference between the date of payment and the day of receiving cash. And here it is, 14 days.

If CCC is shorter, it’s good for a firm; because then the firm can quickly buy, sell, and receive cash from customers and vice versa.

Cash Conversion Cycle Example

First, we will take 3 examples to illustrate DIO, DSO, and DPO. And then, we will take a detailed example to illustrate the whole cash conversion cycle.

Let’s get started.

Days Inventory Outstanding Calculation Example

We have the following information about Company A and Company B.

In US $ Company A Company B
Inventory 10,000 5,000
Cost of Sales 50,000 40,000

We have been given the inventory and cost of sales for both of these companies. So we will calculate the Days Inventory Outstanding by using the formula.

For Company A, the inventory is $10,000, and the cost of sales is $50,000. And we assume that there are 365 days in a year.

So, days inventory outstanding (DIO) for Company A is –

10,000/50,000 *365 = 73 days

For Company B, the inventory is $5,000, and the cost of sales is $40,000. And we assume that there are 365 days in a year.

So, days inventory outstanding (DIO) for Company B is –

5,000/40,000 *365 = 45 days

If we compare the DIO of both the companies, we would see that Company B is in a good position in terms of converting its inventory in cash because it can convert its inventory in cash much sooner than Company A.

Days Sales Outstanding Calculation Example

We have the following information about Company A and Company B.

In US $ Company A Company B
Accounts Receivable 8,000 10,000
Net Credit Sales 50,000 40,000 

We have been given the accounts receivable and net credit salesCredit SalesCredit Sales is a transaction type in which the customers/buyers are allowed to pay up for the bought item later on instead of paying at the exact time of purchase. It gives them the required time to collect money & make the payment. read more for both of these companies. So we will calculate the Days Sales Outstanding by using the formula.

For Company A, the accounts receivable is $8,000, and net credit salesNet Credit SalesNet credit sales is the revenue generated from goods or services sold on credit excluding the sales discount, sales allowance and sales return. It even amounts to the accounts receivables for a certain accounting period.read more are $50,000. And we assume that there are 365 days in a year.

So, days sales outstanding (DSO) for Company A is –

8,000/50,000 *365 = 58.4 days

For Company B, the accounts receivable is $10,000, and net credit sales are $40,000. And we assume that there are 365 days in a year.

So, days sales outstanding (DSO) for Company B is –

10,000/40,000 *365 = 91.25 days

If we compare the DSO of both the companies, we would see that Company A is in a good position in terms of converting its accounts receivable in cash because it can convert it into cash much sooner than Company B.

Days Payables Outstanding Calculation Example

We have the following information about Company A and Company B.

In US $ Company A Company B
Accounts Payables 11,000 9,000
Cost of Sales 54,000 33,000 

We have been given the accounts payables and the cost of sales for both of these companies. So we will calculate the Days Payables Outstanding by using the formula.

For Company A, the accounts payables are $11,000, and the cost of sales is $54,000. And we assume that there are 365 days in a year.

So, days payables outstanding (DPO) for Company A is –

11,000/54,000 *365 = 74.35 days

For Company B, the accounts payables are $9,000, and the cost of sales is $33,000. And we assume that there are 365 days in a year.

So, days payables outstanding (DPO) for Company B is –

9,000/33,000 *365 = 99.55 days

Now which company has better DPO? There are two things we need to consider here. First, if DPO is more, the company has more cash handy, but if you keep the money for a long time, you may miss out on the discount. Second, if DPO is less, you won’t be having more free cash flow and working capital; but you would be able to pay your creditor faster, which will help you build the relationship and also avail the discount.

So now you can understand that the consequence of DPO actually depends on the situation the firm is in.

Cash Conversion Cycle Calculation Example

Let’s take a complete example to find out the Cash Cycle.

We would be taking two companies, and here are the details below.

In US $ Company A Company B
Inventory 3000 5000
Net Credit Sales 40,000 50,000
Accounts Receivable 5,000 6,000
Accounts Payables 4,000 3,000
Cost of Sales 54,000 33,000

Now let’s calculate each of the portions to find out the Cash Cycle.

First, let’s find out Days Inventory Outstanding (DIO) for both the companies.

In US $ Company A Company B
Inventory 3,000 5,000
Cost of Sales 54,000 33,000

So the Days Inventory Outstanding (DIO) would be –

In US $ Company A Company B
DIO (Break-up) 3,000/54,000*365 5,000/33,000*365
DIO 20 days (approx.) 55 days (approx.)

Now let’s calculate Days Sales Outstanding (DSO).

In US $ Company A Company B
Accounts Receivables 5,000 6,000
Net Credit Sales 40,000 50,000

So the Days Sales Outstanding (DIO) would be –

In US $ Company A Company B
DSO (Break-up) 5,000/40,000*365 6,000/50,000*365
DSO 46 days (approx.) 44 days (approx.)

Now let’s calculate the final portion before calculating the Cash Cycle, and that is Days Payables Outstanding (DPO).

In US $ Company A Company B
Accounts Payables 4,000 3,000
Cost of Sales 54,000 33,000

So the Days Payables Outstanding (DPO) would be –

In US $ Company A Company B
DPO (Break-up) 4,000/54,000*365 3,000/33,000*365
DPO 27 days (approx.) 33 days (approx.)

Now, let’s find out the Cash Cycle for both of the companies.

In US $ Company A Company B
DIO 20 days 55 days
DSO 46 days 44 days
DPO 27 days 33 days
CCC (Break-up) 20+46-27 55+44-33
Cash Conversion Cycle 39 days 66 days

We now have the cash cycle for both of the companies. And if we imagine that these companies are from the same industry and if other things remain constant, then in a matter of comparison, Company A has a better hold on their cash cycle than Company B.

As a note, you should remember that when you add DIO and DSO, it’s called the operating cycle. And after deducting the DPO, you may find a negative Cash Cycle. Negative Cash Cycle means the firm is getting paid by their customers long before they ever pay their suppliers.

Apple Cash Cycle (Negative)

Let us have a look at the Cash Cycle of Apple. We note that the cash cycle of Apple is Negative.

Apple Negative Cash Conversion Cycle

source: ycharts

  • Apple Days Inventory Oustanding  ~ 6 days. Apple has a streamlined product portfolio, and its efficient contract manufacturers deliver products quickly.
  • Apple Days Sales Oustanding ~ 50 days. Apple has a dense network of retail stores, where they get paid mostly by Cash or Credit Card.
  • Apple Days Payable Oustanding is ~ 101 days.  Because of big orders to the suppliers, Apple is able to negotiate better credit terms.
  • Apple Cash Cycle Formula = 50 days + 6 days – 101 days ~ -45 days (Negative)

Negative Cash Cycle Examples

Like Apple, there are many companies that have negative cash cycle. Below is the list of top companies with the Negative Cash Cycle.

S. No Name Cash Cycle (days) Market Cap ($ million)
1 China Mobile                                                         (653.90)                                              231,209
2 British American Tobacco                                                         (107.20)                                              116,104
3 AstraZeneca                                                         (674.84)                                                70,638
4 EOG Resources                                                         (217.86)                                                58,188
5 Telefonica                                                         (217.51)                                                48,060
6 TransCanada                                                         (260.07)                                                41,412
7 Orange                                                         (106.46)                                                41,311
8 Anadarko Petroleum                                                         (246.41)                                                39,347
9 BT Group                                                         (754.76)                                                38,570
10 China Telecom Corp                                                         (392.12)                                                38,556
11 Pioneer Natural Resources                                                         (113.37)                                                31,201
12 WPP                                                     (1,501.56)                                                30,728
13 Telekomunikasi Indonesia                                                         (142.18)                                                29,213
14 China Unicom                                                         (768.24)                                                28,593
15 Incyte                                                         (294.33)                                                22,670
16 Telecom Italia                                                         (194.34)                                                19,087
17 Continental Resources                                                         (577.48)                                                17,964
18 Noble Energy                                                         (234.43)                                                17,377
19 Telecom Italia                                                         (194.34)                                                15,520
20 Marathon Oil                                                         (137.49)                                                14,597

source: ycharts

  • WPP has a cash cycle of – 4 years.
  • China Mobile has a cash cycle of -1.8 years.
  • BT Group has a cash cycle Ratio of -2.07 years.

Aaron’s Cash Conversion Cycle – Increasing

Earlier, we looked at examples of WPP that have a cash cycle of -4 years. Let us now take an example of Aaron’s Cash Conversion Cycle that is close to 1107 days ~ 3 years! Why is that so?

Aaron's increasing Cash Conversion Cycle

source: ycharts

Aaron engages in the sales and lease ownership and specialty retailing of furniture, consumer electronics, home appliances, and accessories. Due to the holding of large amounts of inventory, Aaron’s Days Inventory Oustanding has increased continuously over the years. Since there has been not much change in Aaron’s Days Sales Oustanding or Days payables Oustanding, its cash conversion cycle has mimicked the trend of Inventory Oustanding Days.

  • Aaron Days Inventory Oustanding  ~ 1089 days;
  • Aaron Days Sales Oustanding ~ 17.60 days.
  • Aaron Days Payable Oustanding is ~ 0 days.
  • Aaron Cash Cycle = 1089 days + 17.60 days – 0 days ~  1,107 days (Cash Conversion Cycle)

Airline Industry Example

Below is the Cash Cycle Ratio of some of the Top US Airline companies.

S. No Name Cash Cycle (days) Market Cap ($ million)
1 Delta Air Lines                                            (17.22) 35207
2 Southwest Airlines                                                (36.41) 32553
3 United Continental                                                (20.12) 23181
4 American Airlines Group                                                     5.74 22423
5 Ryanair Holdings                                                (16.73) 21488
6 Alaska Air Group                                                   13.80 11599
7 Gol Intelligent Airlines                                                (33.54) 10466
8 China Eastern Airlines                                                     5.75 7338
9 JetBlue Airways                                                (17.90) 6313
10 China Southern Airlines                                                   16.80 5551
  Average                                                   (9.98)

source: ycharts

We note the following –

  • An average Cash conversion ratio of Airline companies is -9.98 days (negative). Overall the airline companies collect their receivables much before they are required to pay what it owes.
  • South Western Airline has a cash conversion of -36.41 days (negative cash conversion)
  • China Southern Airlines, however, has a cash conversion cycle of 16.80 days (above the sector average). It means that China Southern Airlines is not managing its cash cycle properly.

Apparel Industry Example

Below is the Cash Conversion of some of the Top Apparel companies.

S. No Name Cash Cycle (days) Market Cap ($ million)
1 TJX Companies                                                              25.9                                  49,199
2 Luxottica Group                                                              26.1                                  26,019
3 Ross Stores                                                              20.5                                  25,996
4 L Brands                                                              31.1                                  17,037
5 Gap                                                              33.1                                    9,162
6 Lululemon Athletica                                                              83.7                                    9,101
7 Urban Outfitters                                                              41.2                                    3,059
8 American Eagle Outfitters                                                              25.4                                    2,726
9 Children’s Place                                                              47.3                                    1,767
10 Chico’s FAS                                                              32.4                                    1,726
Average                                                              36.7

source: ycharts

We note the following –

  • The average Cash conversion ratio of Apparel companies is 36.67 days.
  • Lululemon Athletica has a cash conversion cycle of 83.68 days (way above the industry average).
  • Ross Stores, however, has a cash conversion of 20.46 days ( below the industry average). It means that Ross Stores is dong much better in managing its inventory, converting receivables to cash, and probably getting a good credit period too from its suppliers of raw material.

Beverages – Soft Drink Industry

Below is the Cash Cycle of some of the Top Soft Drinks companies.

S. No Name Cash Conversion Cycle (days) Market Cap ($ million)
1 Coca-Cola                                                   45.73                               179,160
2 PepsiCo                                                     5.92                               150,747
3 Monster Beverage                                                   59.83                                  24,346
4 Dr Pepper Snapple Group                                                   25.34                                  16,850
5 Embotelladora Andina                                                     9.07                                    3,498
6 National Beverage                                                   30.37                                    2,467
7 Cott                                                   41.70                                    1,481
8 Primo Water                                                     8.18                                        391
9 Reed’s                                                   29.30                                          57
10 Long Island Iced Tea                                                   48.56                                          29
Average                                                   30.40

source: ycharts

We note the following –

  • The average Cash conversion ratio of Soft Drink companies is 30.40 days.
  • Monster Beverage has a cash conversion of 59.83 days (way above the industry average).
  • Primo Water, however, has a cash conversion cycle of 8.18 days ( below the industry average).

Oil & Gas E&P Industry

Below is the Cash Cycle of some of the Top Oil & Gas E&P companies.

S. No Name Cash Conversion Cycle (days) Market Cap ($ million)
1 ConocoPhillips                                                            (14.9)                                  62,484
2 EOG Resources                                                         (217.9)                                  58,188
3 CNOOC                                                            (44.1)                                  56,140
4 Occidental Petroleum                                                            (96.7)                                  52,867
5 Anadarko Petroleum                                                         (246.4)                                  39,347
6 Canadian Natural                                                              57.9                                  33,808
7 Pioneer Natural Resources                                                         (113.4)                                  31,201
8 Apache                                                              33.8                                  22,629
9 Continental Resources                                                         (577.5)                                  17,964
10 Noble Energy                                                         (234.4)                                  17,377
Average                                                         (145.4)

source: ycharts

We note the following –

  • The average Cash conversion ratio of Oil & Gas E&P companies is -145.36 days (negative cash cycle).
  • Canadian Natural has a cash conversion cycle of 57.90 days (way above the industry average).
  • Continental Resources, however, has a cash cycle of -577 days ( below the industry average).

Semiconductors Industry

Below is the Cash Cycle of some of the Top Semiconductor companies.

S. No Name Cash Conversion Cycle (days) Market Cap ($ million)
1 Intel                                                              78.3                               173,068
2 Taiwan Semiconductor                                                              58.7                               160,610
3 Broadcom                                                              53.4                                  82,254
4 Qualcomm                                                              30.7                                  78,254
5 Texas Instruments                                                            129.7                                  76,193
6 NVIDIA                                                              60.1                                  61,651
7 NXP Semiconductors                                                              64.4                                  33,166
8 Analog Devices                                                            116.5                                  23,273
9 Skyworks Solutions                                                              89.6                                  16,920
10 Linear Technology                                                            129.0                                  15,241
Average                                                              81.0

source: ycharts

We note the following –

  • The average Cash conversion ratio of Semiconductor companies is 81 days.
  • Texas Instruments has a cash cycle of 129.74 days (way above the industry average).
  • Qualcomm, however, has a cash cycle of 30.74 days ( below the industry average).

Steel Industry – Cash Cycle

Below is the Cash Cycle of some of the Top Steel companies.

S. No Name Cash Cycle (days) Market Cap ($ million)
1 ArcelorMittal                                                              24.4                                  24,211
2 Tenaris                                                            204.1                                  20,742
3 POSCO                                                            105.6                                  20,294
4 Nucor                                                              75.8                                  18,265
5 Steel Dynamics                                                              81.5                                    8,258
6 Gerdau                                                              98.1                                    6,881
7 Reliance Steel & Aluminum                                                            111.5                                    5,919
8 United States Steel                                                              43.5                                    5,826
9 Companhia Siderurgica                                                            112.7                                    4,967
10 Ternium                                                            102.3                                    4,523
Average                                                              95.9

source: ycharts

  • The average Cash conversion ratio of Steel companies is 95.9 days. We note the following –
  • Tenaris has a cash cycle of 204.05 days (way above the industry average).
  • ArcelorMittal, however, has a cash conversion cycle of 24.41 days ( below the industry average).

Limitations

Even if the Cash cycle is very useful to find out how fast or slow a firm can convert inventory into cash, there are few limitations that we need to pay heed to.

Cash Conversion Cycle Video

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In the final analysis

In the end, now you know how to calculate CCC. However, there is one thing that you should keep in mind. The cash conversion cycle should not be looked at in isolation. One should do a Ratio Analysis to completely understand the fundamentals of the company. Only then will you be able to view holistically. Another important point to note about Cash Cycle is that it should be compared with the Industry Average. With this comparison, we will know how well the company is doing with respect to its peers and whether it stands out or not.

Reader Interactions

Comments

  1. AvatarAniefre Thomas says

    I’ve learned a lot from this blog and I wanted to thank you for you clear and concise explanations about many things myself and my peers have had questions about. These posts make me pumped to learn more and more everyday.

    One of my favorite blogs hands down!

    • Dheeraj VaidyaDheeraj Vaidya says

      thanks Aniefre for the appreciation. I am glad you like this blog :-)

  2. AvatarDyrell Robinson says

    Good stuff man.
    Keep doing this. I appreciate it.

  3. AvatarChoudhary Nafees Ahmed says

    nice article… easy and best example to exlpain Days Inventory Outstanding (DIO) , Days Sales Outstanding (DSO) & Days Payable Outstanding (DPO)