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The cash conversion cycle
Published on November 28, 2019 8 min
Other Talks in the Series: Finance for Non-Finance Professionals
Hi, today we're going to talk about "The Cash Conversion Cycle", sometimes abbreviated in industry as CCC. I'm Professor Michael McDonald. The cash conversion cycle is a critical element in corporate finance. So let's jump in and start learning about it, shall we?
Now, cash as you would expect is key for business. In particular, a company can't function if it runs out of cash. When we talk about companies, we often focus myopically on earnings or profits. Those are certainly important, but they're really an accounting metric. Cash is what allows us to pay our suppliers. It allows us to pay our employees. It allows us to pay our rent. It allows us to deal with emergency issues that come up etc. So when we're looking at a company, we need to decide whether we work at the company or whether we're evaluating an outside firm, we need to decide if that company is in trouble based on its cash flow. One way to do this is with a metric that we call the cash conversion cycle or CCC.
Now the cash conversion cycle is really just a metric for how efficiently and effectively the company is converting it's sales into cash. In particular, the cash conversion cycle is simply composed of the firm's days in receivables plus their days in inventory minus their days in payables. In other words, how long is it taking the company to go from we have a product that we've developed and we're going to sell it plus how long is it taking someone to pay us once we make that sale to them? Companies often extend trade credit, you buy something now, but then you don't pay for it for say 30 day afterwards. We're going to take off of this what we call days in payables, which is how long we get to wait before we pay our suppliers. Days in receivables plus days in inventory are what we call the operating cycle. So our operating cycle minus our days in payables is our cash conversion cycle.