Cash Conversion Cycle (Simplified)

By Bruce Firestone | Uncategorized

Dec 31

Cash Conversion Cycle (CCC) of a business is a crucial metric that can turn a
mediocre enterprise into a great one (i.e., a powerful cash engine) or ruin a
superb business concept or biz model in a hurry because as you grow, you
consume more and more cash. This is not sustainable for entrepreneurial

its essence, the CCC measures the direction and velocity of cash in any
enterprise. Many CEOs or Founders, even of fairly large companies, pay more
attention to their cash position and changes therein than they do to their
accounting statements.

you know just three variables, your bank balance at the beginning and end of
each month as well as your AP (Accounts Payable) and AR (Accounts Receivable)
at the beginning and end of each month, you know what your cash position is,
how it is changing and how much of what is left over actually belongs to you or
your organization.

owner I know who runs a very successful chain of pubs (very), told me he
DECLINES credit from suppliers of food, beer and other inputs because he wants
to know that whatever is left in his bank account at the end of each month
belongs to him– money he can touch, feel and SPEND.

he’s not stupid either. He takes advantage of early pay discounts that range
from 1.5% to 2.5% so, when he pays COD (Cash on Delivery), he’s really making
around 25 points on his dough on an annual basis which is a lot better than the
.7% p.a. your bank gives you these days on money you have on deposit with them
assuming it’s in some kind of savings account or investment account otherwise
the return on cash in your bank (in a current account) is negative with all the
fees and other charges you have to pay on most of these accounts.

cash does not lie but sometimes accounting statements do or, at least, they can
distort reality. A tech company I know nearly went out of business despite the
fact that their revenues were growing fast and they were profitable on an
accruals basis but not in terms of cash. They were taking too long to collect
cash from clients and their bank called their loan. They only avoided
bankruptcy by changing their CCC right away and asking help from their clients,
i.e, it was like the messages you get from your adult kids from time to time
when they are overseas: SEND MONEY NOW, PLEASE.

of getting 10% down with each new contract they sign and the balance on delivery
+ 30 days, they currently ask for and receive 30% down, then two further 30%
progress payments (upon achieving certain milestones) and the balance (just 10
points) on delivery + 30 days. That changes your CCC in a hurry.

get this instinctively. They say, “Collect early and pay late.”

is the CCC formula:


is Accounts Receivable with a time dimension. More about that soon.

is Inventory on hand with a time dimension.

is Accounts Payable with a time dimension.

you calculate these variables this way:

= Accounts Receivable at the end of a time period (month, quarter or fiscal
year typically) x time period / Sales for the period.

= Inventory at the end of a time period (month, quarter or fiscal year
typically) x time period / COGS (Cost of Goods Sold) for the period.

= Accounts Payable at the end of a time period (month, quarter or fiscal year
typically) x time period / COGS (Cost of Goods Sold) for the period.

let’s see if we can figure this out for Acme Promotional Products Inc. (APPI).

has only two lines of business– branded pens and branded mugs. They sell $300
of the former and $200 of the latter in a year so total sales are $500. (Hey,
it’s a pretty small hobby business!)

COGS is 66.667% of their revenues and they pay 1/3 down when they order these
pens or mugs but they ask 50% from their clients when they place an order with

you can see intuitively that this enterprise, even though it is tiny, is cash
accretive. But let’s figure it out exactly.

by the way, they don’t keep any inventory on hand so INVT is going to be 0.
Their suppliers are top notchers, they supply on a JIT (Just-in-Time) basis.

the above equation, gives a CCC = -91.3 days.

(You can download the spreadsheet
that will help you calculate this metric from our server in .xls format and see
how to do this:

is good news! It means that if APPI does grow in the future, the more orders
they get, the more cash they’ll have on hand.

to know how to keep your bank happy? Always make sure they owe you more money
than you owe them.

so what happens if one of your suppliers (say the mug guy) becomes unreliable
and you decide to keep some mugs in inventory? The second tab in the
spreadsheet you now have downloaded will show you what happens to their CCC.
APPI’s COGS on mugs is $133.33 and they have to pay 1/3 down when they order
some inventory so they have $44.44 worth (on a cash basis, this is cash accounting
not accruals remember) of inventory on hand at year end.

their CCC has changed dramatically from a -91.3 days to a +60.9 days. This is

small change (carrying some inventory) has made an enormous difference in their
CCC and now with every order they get, they’ve gone from having cash available
about three months in advance of providing product to their customers to, in
effect, getting paid about two months after each order is delivered. Horrible!

would have to ask clients to put down a 2/3 deposit with each order (instead of
the 50% they’ve been asking for in the past) just to get back to a neutral CCC
(0 days) something clients might push back on, i.e., resist doing. Even if they
get a 90% cash deposit with each order, their CCC is still not as good as the 0
inventory case (it’s now -85 days instead of -91 days.)

can fool around with the spreadsheet and test different scenarios yourself– all
the cells are linked so change one variable and the spreadsheet will do
everything else automatically for you.

there are times when you may want to have a CCC that is not negative. If for
example, you are trying to help a new supplier out, you may pay them early and
take supply later or buy some inventory from them to prop them up until they are
more established. Why would you do that other than the fact that you are such a
nice person? Because you need their unique product or service or they may have
given you an exclusive supply contract which keeps their product out of the
hands of a competitor.

is exactly what AT&T did for Apple– they agreed to give them an
(unprecedented) piece of their subscribers’ monthly revenues in return for an
exclusivity when the iPhone initially launched to keep it out of the hands of
Verizon for a few years during which AT&T added about 9 million new
(mostly) iPhone subscribers.

Steve Jobs and the people at Apple
understood CCC so it’s probably something you will want to use too to better
understand your enterprise. Organizations that set goals and track their metrics
grow 7X faster than those that don’t according to a Silicon Valley study
released in May 2011 (Startup Genome Report 01, Max Marmer, Bjoern Lasse
Herrmann, Ron Berman, 2011: Make sure
that you are in that exclusive group when Max Marmer et al prepare their next

Ottawa, Canada, 2012

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Posted in Business ModelsCash Conversion CycleEntrepreneur Skill SetWhy Businesses Fail

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Bruce is an entrepreneur/real estate broker/developer/coach/urban guru/keynote speaker/Sens founder/novelist/columnist/peerless husband/dad.