The Cash Conversion Cycle
by Wayne A. Thorp, CFA
A recent issue of Computerized Investing explained how to measure a company’s ability to efficiently convert resources into cash flow and why this is important for investors. The relevant ratios used to measure the cash conversion cycle are described below.
For more of this article, see the Fundamental Focus column in the Second Quarter 2011 issue of Computerized Investing.
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Calculating the Cash Conversion Cycle
Through the normal course of business, companies acquire inventory on credit, which they in turn use to create products. These products are then sold, oftentimes on credit. These actions generate accounts payable and accounts receivable, with no cash exchanged until the company collects accounts receivable and settles the accounts payable.
The cash conversion cycle (CCC) measures the time—in days—that it takes for a company to convert resource inputs into cash flows. In other words, the cash conversion cycle reflects the length of time it takes a company to sell inventory, collect receivables, and pay its bills. As a rule, the lower the number, the better. This is because, as the cash conversion cycle shortens, cash becomes free for a company to invest in new equipment or infrastructure or other activities to boost investment return. Also, the cash conversion cycle can be useful in comparing close competitors and assessing management efficiency.
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