Financial Statement Analysis
- Ratio Analysis of Financial Statements (Formula, Types, Excel)
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- Ratio Analysis
- Liquidity Ratios
- Cash Ratio
- Cash Ratio Formula
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- Quick Ratio Formula
- Current Ratio
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- Defensive Interval Ratio
- Working Capital Ratio
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- Net Working Capital Formula
- Changes in Net Working Capital
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- Inventory Turnover Ratio
- Accounts Receivable Turnover
- Accounts Receivables Turnover Ratio
- Accounts Payable Turnover Ratio
- Days Inventory Outstanding
- Days in Inventory
- Days Sales Outstanding
- Days Sales Uncollected
- Average Collection Period
- Days Payable Outstanding
- Cash Conversion Cycle
- Cash Conversion Cycle (CCC) Formula
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- Net Profit Margin Formula
- EBIDTA Margin
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- Capital Gearing Ratio
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- Overcapitalization
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- Times Interest Earned Ratio
- Debt Service Coverage Ratio (DSCR)
- DSCR Formula (Debt service coverage ratio)
- Financial Leverage Ratio
- Financial Leverage Formula
- Degree of Financial Leverage Formula
- Net Debt Formula
- Leverage Ratios
- Leverage Ratios Formula
- Operating Leverage vs Financial Leverage
- Current Yield
- Debt Yield Ratio
- Solvency Ratio Formula
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Cash Conversion Cycle – Here’s we have Amazon and Ford’s chart of Cash Conversion Cycle (CCC). 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 Cash Conversion Cycle matter for a company? If it matters, how do we calculate it?
In this article, we will go in depth and understand Cash Cycle (CCC)
- What is Cash Conversion Cycle?
- Cash Conversion Cycle Formula
- Interpretation of Cash Conversion Cycle
- Cash Conversion Cycle Example
- Apple Cash Cycle (Negative)
- Negative Cash Cycle Examples
- Aaron’s Cash Cycle – Increasing
- Airline Industry – Cash Cycle
- Apparel Industry – Cash Cycle
- Beverages – Soft Drink Industry – Cash Cycle
- Oil & Gas E&P Industry – Cash Cycle
- Semiconductors Industry – Cash Cycle
- Steel Industry – Cash Cycle
- Limitations of Cash Cycle
- In the final analysis
What is Cash Conversion Cycle?
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, cash conversion cycle 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 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. This cash conversion cycle is also called as cash cycle.
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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 Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payable Outstanding (DPO)
Now let’s understand each of them.
DIO stands for Days Inventory Outstanding. 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 with an example.
DSO stands for Days Sales Outstanding. How would we calculate it? Here’s how. Take accounts receivable. 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 example section.
DPO stands for Days Payable Outstanding. 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 period 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 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 Cash Conversion Cycle
Cash Conversion Cycle 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 done 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.
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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 1^{st} April. And the date of receiving the cash from customers is on 15^{th} April. That means 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
Let’s take four examples through which we would be able to understand the whole cash conversion cycle so very well.
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 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 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 sales 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 sales 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 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 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 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 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 same industry and if other things remain constant, then in a matter of comparison, Company A has a better hold on their cash conversion cycle than Company B.
As a note, you should remember that when you add DIO and DSO, it’s called operating cycle. And after deducting the DPO, you may find negative Cash Conversion Cycle. Negative Cash Conversion 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 cash cycle of Apple is Negative.
source: ycharts
- Apple Days Inventory Oustanding ~ 6 days. Apple has a streamlined product portfolio and their 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 Conversion Cycle Formula = 50 days + 6 days – 101 days ~ -45 days (Negative Cash Conversion Cycle)
Negative Cash Cycle Examples
Like Apple, there are many companies that have negative cash cycle. Below is the list of top companies with Negative Cash Conversion 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 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?
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 Conversion Cycle Formula = 1089 days + 17.60 days – 0 days ~ 1,107 days (Cash Conversion Cycle)
Let us now look at Cash Conversion Cycles of some important Industries.
Airline Industry – Cash Conversion Cycle
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 –
- Average Cash conversion ratio of Airline companies is -9.98 days (negative cash conversion cycle). Overall the airline companies collect its receivables much before they are required to pay what it owes.
- South Western Airline has a cash conversion cycle of -36.41 days (negative cash conversion cycle)
- China Southern Airlines, however, has a cash conversion cycle of 16.80 days (above the sector average). This means that China Southern Airlines is not managing its cash cycle properly.
Apparel Industry – Cash Conversion Cycle
Below is the Cash Conversion Cycle of some of the Top Apparel companies.
S. No | Name | Cash Conversion 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 –
- 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 cycle of 20.46 days ( below the industry average). This 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 – Cash Conversion Cycle Ratio
Below is the Cash Conversion 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 –
- Average Cash conversion ratio of Soft Drink companies is 30.40 days.
- Monster Beverage has a cash conversion cycle 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 – Cash Conversion Cycle Ratio
Below is the Cash Conversion 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 –
- Average Cash conversion ratio of Oil & Gas E&P companies is -145.36 days (negative cash conversion 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 – Cash Conversion Cycle
Below is the Cash Conversion 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 –
- 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 Conversion 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
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 of Cash Conversion Cycle
Even if Cash cycle is very useful to find out how fast or slow a firm can convert inventory into cash, there are few limitations which we need to pay heed to.
- Somehow, the Cash Conversion Cycle calculation is dependent on many variables. If one variable is calculated wrong, it would affect the whole Cash Cycle and may affect the decisions of the firm.
- The calculation of DIO, DSO and DPO are done after taking care of everything. So the chances of using the accurate information are somewhat bleak.
- To come out with Cash Conversion Cycle, one firm can use several inventory valuation methods. If a firm changes its inventory valuation method, CCC changes automatically.
Cash Conversion Cycle Video
Related Posts
- Days Sales Uncollected
- Operating Cycle Formula
- Valuation Methods
- DSCR Ratio
- Asset Turnover Ratio
- EBIT vs EBITDA
- Financial Modeling Training
- Basics of Financial modeling
In the final analysis
At the end, now you know how to calculate CCC. However, there is one thing that you should keep in mind. Cash conversion cycle should not be looked at in isolation. One should do 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.
Aniefre 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 Vaidya says
thanks Aniefre for the appreciation. I am glad you like this blog 🙂
Dyrell Robinson says
Good stuff man.
Keep doing this. I appreciate it.
Dheeraj Vaidya says
thanks Dyrell!
Choudhary Nafees Ahmed says
nice article… easy and best example to exlpain Days Inventory Outstanding (DIO) , Days Sales Outstanding (DSO) & Days Payable Outstanding (DPO)
Dheeraj Vaidya says
Many thanks!