Advantages and Disadvantages of Cash Conversion Cycle
Cash Conversion Cycle is the amount of time that a company spends to convert from investment into cash through the sale of inventory. It is the amount of time that company needs to use its resource to purchase inventory, sale and collect cash from the customer.
Cash conversion cycle is the total of inventory day outstanding and day sale outstanding less day payable outstanding. Inventory day is the number of days that a company spends to convert inventory to sale. While the day sale outstanding is the time company needs to collect cash from its receivable. Day payable outstanding is the number of days that a company pays off its accounts payable.
The company uses the available cash on hand to pay for suppliers and receive inventory. Then use the inventory to sell and get even more cash. It shows how many days that company needs to complete one cash cycle.
Cash Conversion Cycle Formula
|CCC = Inventory Day Outstanding + Day Sale Outstanding – Day Payable Outstanding
Advantages of Cash Conversion Cycle
- To see the overall picture of the company: It shows the overall cash flow within the company. The faster they can convert cash, the better their cash flow is.
- To access the company’s financial health: More cash flow into the company show that they are doing well. It will reduce the risk of liquidation which incur due to lack of cash flow to pay for suppliers, employees and creditors.
- Set KPI for management: The cash conversion cycle can be used as the KPI for the management to expand the business operation. We can get the figure from the benchmark of past data and industry average.
Disadvantages of Cash Conversion Cycle
- Different from one industry to another: cash conversion cycle is hard to compare from one industry to another.
- In order to keep the CCC in short term, the company needs to sell the inventory and then collect the money as fast as possible. On the other hand, we need to delay the payment to the supplier as long as possible. By doing so, it will impact the relationship with customers and suppliers. They will not happy to do business with us in the long run.