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4 Examples of the Cash Conversion Cycle

 , January 23, 2019
The cash conversion cycle is the amount of time that it takes inventory costs to result in revenue. This is calculated using the difference between the time you pay suppliers and the time that customers pay you. The following are illustrative examples.

Negative

In theory, your cash conversion cycle can be negative if you are able to sell your products and collect from customers before paying suppliers. For example, an ecommerce site that pays suppliers in an average of 42 days, sells goods in an average of 21 days and collects from customers within 3 days has the following cash conversion cycle.
CCC = Inventory conversion period + receivables conversion period - payables conversion period

= (21 + 3) - 42

= -18 days
A negative cash conversion cycle is a good thing and is indicative of an efficient business that has power over its suppliers. In practice, this is rare as businesses typically build inventory in support of marketing and sales. In other words, businesses are more likely to try to maximize total revenue as opposed to minimizing the cash conversion cycle. In the example above, the ecommerce site may be able to increase revenue by having more variety in stock at all times at the cost of increasing the inventory conversion period and the cash conversion cycle.

Short

Firms that can quickly manufacture products, minimize supply chain inventory and receive prompt payments from customers have a short cash conversion cycle. For example, a fast moving consumer goods company that pays suppliers in an average of 12 days, sells goods in an average of 18 days and collects from customers within 14 days has the following cash conversion cycle.
CCC = Inventory conversion period + receivables conversion period - payables conversion period

= (18 + 14) - 12

= 20 days

Long But Normal

The level of cash conversion cycle that is considered normal differs by industry and region. For example, an airplane manufacturer may have a very long cash conversion cycle because it takes many days to construct an airplane and payment terms may be generous for large purchases. For example, a firm with an inventory conversion period of 95 days, receivables conversion period of 30 days and payables conversion period of 25 days.
CCC = Inventory conversion period + receivables conversion period - payables conversion period

= (95 + 30) - 25

= 100 days

Long & Problematic

A long cash conversion cycle occurs when inventory is sitting around in warehouses due to operations or marketing failures. A long cycle can also be caused by an inability to collect from customers quickly or suppliers that demand immediate payment because they don't trust you to pay. For example, a solar panel manufacturing firm has a high debt load and poor financial reputation such that customers are hesitant to buy and suppliers demand immediate payment. This causes inventory conversion period to expand to 120 days, receivables conversion period to expand to 45 days and payables conversion period to shrink to 5 days.
CCC = Inventory conversion period + receivables conversion period - payables conversion period

= 120 + 45 - 5

= 160 days
An abnormally long cash conversion cycle, particularly in an industry where inventory is a major expense, is indicative of a firm that is struggling to compete or that is poorly managed.
Overview: Cash Conversion Cycle
Type
Definition
The amount of time that it takes inventory costs to result in revenue.
Calculation Formula
Cash conversion cycle = Inventory conversion period + receivables conversion period - payables conversion period
Units
Days
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