what the cash conversion cycle can tell you
boosting sales of inventory for profit is the primary way for a business to make more earnings but how does one sell more stuff if cash is easily available at regular intervals then one can churn out more sales for profits as frequent availability of capital leads to more products to make and sell a company can acquire inventory on credit which results in accounts payable ap a company can also sell products on credit which results in accounts receivable ar therefore cash isn t a factor until the company pays the accounts payable and collects the accounts receivable timing is thus an important aspect of cash management ccc traces the life cycle of cash used for business activity it follows the cash as it s first converted into inventory and accounts payable then into expenses for product or service development through to sales and accounts receivable and then back into cash in hand essentially ccc represents how fast a company can convert the invested cash from start investment to end returns the lower the ccc the better inventory management sales realization and payables are the three key ingredients of business if any of these goes for a toss say inventory mismanagement sales constraints or payables increasing in number value or frequency then the business is set to suffer beyond the monetary value involved ccc accounts for the time involved in these processes which provides another view of the company s operating efficiency in addition to other financial measures the ccc value indicates how efficiently a company s management is using the short term assets and liabilities to generate and redeploy the cash and gives a peek into the company s financial health with respect to cash management the figure also helps assess the liquidity risk linked to a company s operations special considerationsif a business has hit all the right notes and is efficiently serving the needs of the market and its customers it will have a lower ccc value ccc may not provide meaningful inferences as a stand alone number for a given period analysts use it to track a business over multiple time periods and to compare the company to its competitors tracking a company s ccc over multiple quarters will show if it is improving maintaining or worsening its operational efficiency while comparing competing businesses investors may look at a combination of factors to select the best fit if two companies have similar values for return on equity roe and return on assets roa it may be worth investing in the company that has the lowest ccc value it indicates that the company is able to generate similar returns more quickly ccc is also used internally by the company s management to adjust their methods of credit purchase payments or cash collections from debtors example of how to use the cash conversion cycleccc has a selective application to different industrial sectors based on the nature of business operations the measure has great significance for retailers like walmart inc wmt target corp tgt and costco wholesale corp cost which are involved in buying and managing inventories and selling them to customers all such businesses may have a high positive value of ccc however ccc does not apply to companies that don t have need for inventory management software companies that offer computer programs through licensing for instance can realize sales and profits without the need to manage stockpiles similarly insurance or brokerage companies don t buy items wholesale for retail so ccc doesn t apply to them businesses can have negative cccs like online retailers ebay inc ebay and amazon com inc amzn often online retailers receive funds in their accounts for sales of goods that actually belong to and are served by third party sellers who use the online platform however these companies don t pay the sellers immediately after the sale but may follow a monthly or threshold based payment cycle this mechanism allows these companies to hold onto the cash for a longer period of time so they often end up with a negative ccc additionally if the goods are directly supplied by the third party seller to the customer the online retailer never holds any inventory in house a harvard business blog post attributes the negative ccc as a key factor in amazon s survival of the dot com bubble of 2000 operating with a negative ccc became a source of cash for the company instead of being a cost for it 1