Question

Explain the cash conversion cycle (CCC). Describe the CCC for your employer or company in an industry in which you're interested. What are some specific things that your company could do to decrease your cash conversion cycle? Let's be sure to describe, in pretty specific terms, the CCC for our company and what could be done to shorten it.

Answer 1

The cash cycle (also called cash conversion cycle) measures how long it will take to convert the company‘s cash into inventory and inventory into receivables and the receivables into cash. It’s a measurement of time that elapses since the actual cash outflow towards acquisition of raw material to the actual cash inflow as payment from customer on account of sales. This is also called net operating cycle.

A very long cash conversion cycle implies the excessive capital is blocked in the cycle.

In order to calculate the cash conversion cycle, we need to calculate the three individual components as:

An example from my employer's balance sheet

We have 30 days sales credit period. All our sales take place in credit. We hold inventory for 15 days and the payments are made to the suppliers within 21 days.

Hence, our cash conversion cycle = 15 + 30 - 21 = 24 days

What can be done to shorten the cash conversion cycle:

1. We can reduce the credit period to our customers. We can introduce some immediate discount scheme on immediate payment, so that customers get attracted towards cash sales and not towards credit sale. We have to incentivize the customers to opt for cash sales rather than credit sales.
2. Inventory holding period has to be reduced: sales have to be faster or we need to reduce the inventory we hold in our hand. The inventory can be held at the vendor's premises. We may have to opt for schemes like Vendor managed inventory or Just in Time inventory models.
3. Credit period from suppliers have to be renegotiated. We can ask for higher credit period from suppliers.