Basic Understanding of the term:Cash Conversion Cycle/Daily Operating Cycle or Day Working Capital

A business besides focussing on making profit should consider its cash flow. One of the key performance metrics to assist management in gauging the "cash" performance is to fine-tune or quicken the pace of the company's cash conversion cycle or daily operating cycle or day working capital.

Below article looks at the some details of the aforesaid terms in the context of managing business finance of a company:

(a) The importance of understanding cash conversion cycle or daily operating cycle or day working capital:

• it is actually another simple way of looking at working capital management,
• by improving CCC, we are able to balance sales growth with the required liquidity to fuel the growth,
• with an adverse CCC, survival of the company is at stake particularly when the company is overtrading and recession is around.

Is the CCC a new thing?

No, the CCC’s existence is as old as when accountants were looking into ways of how to reduce or manage the dollars tied up in the working capital of accounts receivable and stocks and optimizing the period owing to accounts payables.

(b) Definition of Cash conversion cycle:

• it represents the amount of time in terms of the number of days between the purchase of materials by a company to produce its end products and the receipt of payment for those end products in the supply chain, it represents the amount of time it takes to turn a dollar spent with a supplier into a dollar received from an end customer. It sounds familiar isn’t it , it is really the operating cycle of a company we are talking about.

Logically, the CCC is so critical as a company with a low CCC is more efficient as it is able to turns its products into cash more efficiently, minimizing the non productive working capital tied up in its business & making more cash available to fund growth and create shareholder value

A basic model of the CCC is as follows :

DSO (Days Sales Outstanding) plus: DIO (Days Inventory Outstanding) less: DPO (Days Purchases Outstanding) = CCC (Cash Conversion Cycle / Day Working Capital)

Let’s try to understand the various definitions involved:

• Days Sales Outstanding or DSO represents number of days, the Accounts Receivable (AR) is outstanding in term of number of days of sales.

• Days Inventory Outstanding or DIO is then represents the number of days, the Inventory is outstanding in term of number of days of Cost of sales.

• Days Purchases Outstanding or DPO represents no of days, the Accounts Payable is outstanding in term of number of days of Purchases

Now, it sounds familiar like it is another ratio of working capital. The difference is that CCC is represented in terms of time or number of days.

(c) The advantages of using cash conversion cycle/daily operating cycle as one of the key performance index:

• CCC as a performance metric is indeed a very simple, easy to understand and to use & is a flexible tool for understanding the favourable or adverse changes in working capital management.
• Surveys conducted by reputable accountancy bodies like CFO Asia.com includes CCC as part of their key performance metric to rank good performers amongst companies in similar industry.