A business’s cash conversion cycle, or CCC, is the amount of time it takes to convert inventory or resources into cash in hand. When a business is operating efficiently, it typically has a low CCC. Longer CCCs mean that it takes longer for a business to make sales or collect payments on invoices.
Reducing the time that it takes to convert cash can help improve your cash flow. Here’s how to reduce your CCC.
Determine Your Cash Conversion Cycle by Calculating
Before you take steps to reduce your CCC, you first need to know how long it currently takes your business to convert cash.
You can use the standard cash cycle formula for your cash conversion cycle calculation. But first, you need to determine what period of time you want to calculate your CCC for – quarter, year, etc. Many businesses find that calculating for a 13-week period is ideal.
To calculate your CCC, you will need to gather some information from your balance sheets and income statements, including:
- A/R for the beginning/end of the period
- A/P for the beginning/end of the period
- Value of your inventory at the beginning/end of the period
- Revenue for the period
- The cost of the goods sold for the period
Now, plug this information into the CCC formula:
- CCC = DIO (Days in Inventory Outstanding) + DSO (Day Sales Outstanding) – DPO (Days Payables Outstanding)
To calculate DIO, use the following formula:
- ((Starting inventory value + ending inventory value) / Cost of goods sold/2)) * Calculation Period
To calculate DSO, use the following formula:
- ((Starting accounts receivable + ending accounts receivable) / (Revenue * 2)) * Calculation Period
To calculate DPO, use the following formula:
- ((Starting accounts payable + ending accounts payable) / (Cost of goods sold * 2)) * Calculation Period
Plug all of this information into the formula above to calculate your CCC.
What Makes a Successful Cash Conversion Cycle?
A negative cash conversion cycle is a sign that your business isn’t converting cash quickly enough. But what exactly makes a successful CCC?
As a general rule of thumb, you want to aim to make your CCC as short as possible. The best way to determine whether you have a successful CCC is to benchmark it against past performance. Alternatively, you can compare your CCC to your competitors.
Trending your CCC against your calculations from previous quarters or years can help you determine whether your cycle is improving.
If your current CCC is shorter than past cycles, then this is a sign of a successful CCC.
The Ways to Reduce Your Cash Conversion Cycle
Businesses should always aim to reduce their cash conversion cycle. There are several ways to achieve this goal.
Invest in Cash Flow Tools
One simple way to reduce your CCC is to start using automated cash flow tools. These tools can provide valuable insights and data that you can use to shorten your cycle.
For example, a Xero cashflow app can provide you with information on how quickly customers pay and your best customers (fastest paying). With this information, you can adjust payment terms for some clients to ensure they pay more quickly.
Cash flow tools will also save you time when making forecasts and managing your business’s finances. But they’ll also make it easier to calculate your CCC and measure improvements along the way.
Encourage Quicker Payments
The quicker customers pay, the better. Rather than simply focusing on penalizing late-paying customers, focus on providing incentives for clients to make payments early.
You can encourage faster payments by:
- Offering discounts for paying before the due date.
- Offering faster shipping for early payments.
- Offer better credit terms if payments are made early and in full.
Offering incentives is a great way to get payments faster. Clients benefit from these incentives, so they’re far more likely to make payments earlier.
Final Thoughts
Reducing your CCC will help your business maintain a steady and healthy cash flow. The first step is to calculate your cash conversion cycle, and then use this information to shorten your cycle as much as possible.
Using cash flow tools and offering incentives for early payments are two simple, effective ways to reduce your CCC without affecting the sustainability of your business.
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