Importance of Cash Conversion Cycle. Today, we are going to mention about cash conversion cycle.
This notion is very important for companies. Especially for companies operating under inflation and intense competition.
If they can manage their cash conversion cycle, they won’t encounter cash flow problems.
They can make their supplier payments, salaries or that kind a expense. Otherwise, wrong management can caused by bankruptcy.
This is why, the companies must pay attention the cash conversion cycle management.
What is the cash conversion cycle?
First of all, this one is a cycle of money. Think about it. You have a company and you are purchasing some products and selling to your customers.
This cycle is obtaining all money process of your company-supplier-customer. This triangle is like life cycle. Because the companies need the cash to sustain their life.
Cash conversion cycle management is easier than less inflation rate and less competation countries.
Because competation forces more less price policy. In the end of the strict competation some companies has to bankruptcy.
Sometimes some companies can give up their margins for competation with other players. This one is huge problem.
3 different notions are effecting to cash conversion cycle.
- DIO (Days Inventory Outstanding)
- DSO(Days Sales Outstanding)
- DPO (Days Payable Outstanding)
We can explain the DIO like that: The average number of days a company holds inventory before selling it.
We can explain the DSO like that: The average number of days it takes to collect payment from customers.
We can explain the DPO like that: The average number of days a company takes to pay its suppliers.
The cash conversion cycle is includin these 3 different notions. The calculation must be like in the below:
CCC(Cash Conversion Cycle) = DIO + DSO − DPO
Let me explain with a sample:
- DIO = 50 days
- DSO = 30 days
- DPO = 40 days
CCC= 50+30-40=40 Days.
This calculation means the company needs 40 days to convert its inventory investment into cash.
So more clearly, your company purchased some products and sold to customers, your company will get this revenue after 40 days.
Advanteges
A shorter CCC means:
-
Faster cash recovery
-
Better liquidity
A longer CCC means:
-
Slow inventory turnover
-
Delayed customer payments
My dear reader, I hope eveything is clear in your mind about CCC. I hope you will read this and you will use this information in your life or your company.
Thank you very much for reading.
Berkay.
