Introduction
The cash conversion cycle (CCC) is a metric that measures how long it takes a company (in days) to transform its stock and other resources or financial assets into sales cash flows. The cash cycle, also known as the net operating cycle, attempts to measure how long each net input dollar is tied up before it is converted into cash received, the manufacturing and sales process This metric takes into account how long it takes for the company to sell inventory and pay bills.
Uses of the cash conversion cycle
The CCC tracks the life cycle of cash used in business. It tracks the cash as it is transformed into inventory and accounts payable, then into product or service development costs, sales and accounts receivable, and finally coming back into cash in hand. CCC mainly shows how quickly a company can convert invested cash from start to finish (investment to exit) (returns).
Advantages and disadvantages of the cash conversion cycle
Advantages
- If the debtor conversion cycle is good, there will be fewer bad debts associated with it. As a result, the company would not have to rely on outside agencies or include a large amount of uncollectible in their financials.
- The incentive system can be tailored to the firm's cash conversion cycle. For example, if the debtors' collection period is to be reduced, the firm can offer discounts for instant or early payments.
- Older inventory in storage houses poses a risk to the company in terms of high retention costs, spoilage risks, and quality degradation. If the company can maintain a healthy inventory conversion rate, it can help to improve overall production and business quality.
- On the other hand, a low payables conversion rate ensures that the company can take advantage of the incentives that suppliers will offer for instant payments. It also strengthens the relationship, and the company can benefit from a shorter production cycle than its competitors.
Disadvantages
- To ensure that the cash conversion cycle is always positive, the business has a tendency to clear the dues to the suppliers as soon as possible. This limits the use of the funds that the company can make of them. It can instead use the funds that will eventually be paid to assist with other functions that can improve the various aspects in which it lags.
- It is not the most accurate indicator of a company's efficiency. It simply discusses the period during which the dues are cleared, which is a good indicator of the business's liquidity and operational viability. However, there are numerous aspects that are not addressed. An improved cash conversion cycle compared to competitors is generally regarded as a positive sign by management.
- Furthermore, the industry's standards for the cash conversion cycle vary depending on market conditions and changes in the business environment. It would be foolish to continue to adhere to the traditional definition and acceptable standard.
