Cash Conversion Cycle Formula and Examples

What is the Cash Conversion Cycle (CCC)?

The cash conversion cycle measures the amount of time it takes for a business to convert its cash investments in raw materials or inventory into cash from product sales. It is an important measure of the business cycle that shows how long a company will have to wait from its initial investment in production material to actually receiving cash. Part of the cash conversion cycle includes the time delay in collecting accounts receivables. 

What is the Cash Conversion Cycle Formula?

The entire cash conversion cycle is the sum of three separate stages. The formula for the cash conversion cycle is:

Cash Conversion Cycle = DIO + DSO - DPO

Where:

• DIO = Days of inventory outstanding
• DSO = Days sales outstanding
• DPO = Days payables outstanding

Days of inventory outstanding and days sales outstanding relate to the inventory and accounts receivable cycles. Both are measuring eventual cash inflows related to asset accounts. Days payables outstanding is subtracted because it relates to accounts payable– an eventual cash outflow and liability account. Let’s now breakdown each of the three components:

Days of Inventory Outstanding

The formula for days of inventory outstanding is:

DIO = (Average Inventory / COGS) x Days in Period

Where: 

• Average Inventory = (Beginning Inventory + Ending Inventory) / 2
• COGS = Cost of goods sold

Inventory is listed in the asset section of the balance sheet. The beginning inventory balance is the ending inventory from the prior period’s balance sheet. The ending inventory balance is the ending inventory from the current period’s balance sheet. Cost of goods sold is listed on the company’s income statement.

The DIO represents the length of time that cash is tied up in inventory before a sale is made. It measures a company’s ability to convert an investment in production material into a sale. A shorter DIO means the company is faster at selling its inventory.

Days Sales Outstanding

The formula for days sales outstanding is:

DSO = (Average Accounts Receivable / Revenue) x Days in Period

Where: 

• Average Accounts Receivable (AR) = (Beginning AR + Ending AR) / 2

Accounts receivable is listed in the asset section of the balance sheet. The beginning AR balance is the ending AR from the prior period’s balance sheet. The ending AR balance is the ending AR from the current period’s balance sheet. Revenue is the top line of the company’s income statement. 

The DSO represents the length of time from the sale of a product to the actual collection of cash. It measures a company’s ability to convert credit sales to cash quickly. A shorter DSO means the company is faster at converting its accounts receivable into cash.

Days Payables Outstanding

The formula for days payables outstanding is:

DPO = (Average Accounts Payable / COGS) x Days in Period

Where: 

• Average Accounts Payable (AP) = (Beginning AP + Ending AP) / 2
• COGS = Cost of goods sold

Accounts payable is listed in the liability section of the balance sheet. The beginning AP balance is the ending AP from the period period’s balance sheet. The ending AP balance is the ending AP from the current period’s balance sheet. Cost of goods sold is listed near the top on the company’s income statement. 

The DPO represents the length of time a company takes to pay its suppliers for inventory it has purchased on credit. A larger DPO means the company is holding onto its cash longer. Rather than paying its vendors for inventory and raw materials that have not been converted to cash sales yet, it is holding onto cash that can be used for other investment opportunities.

Example of Cash Conversion Cycle

ABC Company reported $20,000 in inventory, $40,000 in AR, and $25,000 in AP at the end of the prior period on its comparative balance sheet. It had $30,000 in inventory, $60,000 in AR, and $45,000 in AP at the end of the current period on its comparative balance sheet. It had $500,000 in sales revenue and $200,000 in COGS on the income statement. The fiscal period was a 365 day year. 

Using these figures, the three segments of the cash conversion cycle can be calculated as follows:

DIO = [($20,000 + $30,000) / 2] / $200,000 x 365 Days = 45.63

Where:

• $20,000 = Beginning inventory
• $30,000 = Ending inventory
• $200,000 = COGS

This means it takes approximately 46 days to turn the company’s inventory into a sale. 

DSO = [($40,000 + $60,000) / 2] / $500,000  x 365 Days = 36.5

Where:

• $40,000 = Beginning AR
• $60,000 = Ending AR
• $500,000 = Sales Revenue

This means the company collects cash for its credit sales in approximately 37 days. 

DPO = [($25,000 + $45,000) / 2] / $200,000 x 365 Days = 63.88

Where:

• $25,000 = Beginning AP
• $45,000 = Ending AP
• $200,000 = COGS

This means the company takes approximately 64 days to pay its invoices from vendors.

The full cash conversion cycle can then be calculated as:

CCC = 45.63 + 36.5 - 63.88 = 18.25

Where:

• 45.63 = DIO
• 36.5 = DSO
• 63.88 = DPO

In total, the cash conversion cycle takes approximately 18 days. This means the company can turn a cash investment in its inventory or raw materials into cash from a sale in approximately 18 days. For ABC Company, it is keeping this number low by taking its time to pay its vendors for the production materials. ABC’s AP balance is even higher than its inventory balance at the end of both periods. The main delay in the cash conversion cycle is the time it takes to collect cash from customers after a credit sale.

Real Company Example: Walmart’s Cash Conversion Cycle

Walmart has the following income statement and balance sheet details in its 2023 Annual Report. 

Using the figures from above, the three segments of the cash conversion cycle can be calculated as follows:

DIO = [($56,511 million + $56,576 million) / 2] / $463,721 million x 365 Days = 44.51

Where:

• $56,511 million = Beginning inventory
• $56,576 million = Ending inventory
• $463,721 million = COGS

This means it takes approximately 45 days to turn Walmart’s inventory into a sale. 

DSO = [($8,280 million + $7,933 million) / 2] / $611,289 million  x 365 Days = 4.84

Where:

• $8,280 million = Beginning AR
• $7,933 million = Ending AR
• $611,289 million = Sales Revenue

This means Walmart collects cash for its sales in approximately 5 days. 

DPO = [($55,261 million + $53,742) / 2] / $463,721 million x 365 Days = 42.90

Where:

• $55,261 million = Beginning AP
• $53,742 million = Ending AP
• $463,721 million = COGS

This means Walmart takes approximately 43 days to pay its invoices from vendors.

The full cash conversion cycle can then be calculated as:

CCC = 44.51 + 4.84 - 42.90 = 6.45

Where:

• 44.51 = DIO
• 4.84 = DSO
• 42.90 = DPO

The total cash conversion cycle is 6.45 days from Walmart making a cash investment in its inventory until it receives the cash from the sale. Walmart has a very short period of time in which it collects cash from credit sales. Its days in inventory outstanding and days payables outstanding are very similar. Overall, it has a very low CCC and indicates that Walmart is efficiently managing its inventory and sales processes.

What is a Good Cash Conversion Cycle?

A good cash conversion cycle varies depending on the industry. As such, it is prudent to only compare companies in the same industry when analyzing CCC. Typically, the lower the CCC the better. A company with a trend of decreasing CCC over time indicates they are becoming more efficient with their management of cash and the sales cycle.

What is a Negative Cash Conversion Cycle?

A negative cash conversion cycle occurs when a company makes sales and receives cash faster than it pays its vendors for the inventory or raw materials required to produce the sale. This means the company’s vendors are effectively financing the company’s operations. An example of this is Apple, which as of 2022, it has a negative cash conversion cycle of -60 days as it’s figured out how to sell its product faster than the length of time it takes to pay its accounts payable.

Additional Resources

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