Cash Conversion Cycle (CCC) is a key performance indicator that measures the amount of time taken by a company to convert its investment in inventory into sales. It determines the number of days that the company has to hold its cash in inventory or other assets before realizing cash for its sales. The cash conversion cycle is calculated by using the following formula:
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- Cash Conversion Cycle = Days Inventory Outstanding + Days Sales Outstanding – Days Payable Outstanding (Allman-Ward & Allman-Ward, 2018).
There are three components of this metric including Days Inventory Outstanding, Days Sales Outstanding, and Days Payable Outstanding. The Days Inventory Outstanding (DIO) is a measure of the number of days for which a company holds its inventory in its stores or warehouse before selling it. The primary aim of a company is to make quick sales and have a shorter DIO. Any delay in sales will result in cash flow problems for the company, which could affect its ability to carry out its business activities efficiently.
The second component of the CCC is Days Sales Outstanding (DSO) which is a measure of the number of days for which a company has to wait to receive cash/payment for its sales. Most of the companies sell their products or services on credit which means that they will receive payments from customers at later dates. If customers delay payments or fail to make payments, then the company will have cash flow problems. The third component is Days Payable Outstanding (DPO) which determines the number of days taken by the company to pay its suppliers who expect timely payments to deliver goods for sale. Therefore, it is crucial for companies to keep a low value of DPO to have good relationships with their suppliers (Allman-Ward & Allman-Ward, 2018).
The analysis of the cash conversion cycle is vital for businesses as it helps them in determining their weaknesses and addressing them through changes in their strategies and operational tactics. The longer is the cash conversion cycle, the more problematic it is for the company as it will not have liquid cash to expand its sales. It helps them in improving their relationships with suppliers and negotiating a better deal in terms of lower cost or timely delivery of goods to be sold. As it is indicated that it is crucial for companies to keep their cash conversion cycle low to avoid financial difficulties, the management integrates its assessment in its dealings with customers and suppliers. If a company has a longer days sales outstanding, then it can offer a discount to its customers for early payment to speed up the cash realization process (Allman-Ward & Allman-Ward, 2018).
Furthermore, if the company has cash flow delays, it must communicate with its suppliers to inform them about it and try to get additional time for payments. Moreover, if the company has a negative cash conversion cycle, then it means that it is not paying its suppliers before receiving cash from its customers (Takai, 2018).
The cash conversion cycle of Walmart Inc. (Walmart) is given in the Appendix. The DIO of Walmart was 42.44 days in 2018, which is considered as an extended period for a retail company to hold its inventory. It implies company held its inventories for more than one month before selling them. It is reported that the company sells not only food items but also household items that take a longer time to sell. The DSO of the company was 4.18 days which means that the company received cash for its sales in 2018 in a short period. It was a positive sign as the company had no significant issues in the realization of cash.
The DPO of the company was 42.78 days, which is almost equal to the DIO. It shows that the company effectively managed its payments for the goods that it purchased from its global suppliers. The company can improve its cash flows by increasing its sales of fast-moving items and profitability. It must improve its customer service and the quality of products. The company should reduce the level of its slow-moving inventory. Also, it can offer discounts to its customers to speed up sales and avoid large inventories.
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Allman-Ward, M., & Allman-Ward, A. P. (2018). Optimizing company cash: A guide for financial professionals. Hoboken, NJ: John Wiley & Sons.
Takai, S. (2018). Guide to management accounting CCC (cash conversion cycle) for managers. Osaka, Japan: IFC Consulting Ltd.
Table 1. Cash Conversion Cycle – Walmart Inc.
|Cash Conversion Cycle||Formula||2018||2017|
|Cash Conversion Cycle||DIO+DSO-DPO|
|Days Inventory Outstanding (DIO)|
|Cost of Sales||373,396.00|
|DIT||Average Inventory / (Cost of Sales/365)||42.44|
|Days Sales Outstanding (DSO)|
|Average Accounts Receivable||5,724.50|
|DSO||Average Accounts Receivable / (Revenue/365)||4.18|
|Days Payable Outstanding (DPO)|
|Average Accounts Payable||43,762.50|
|Cost of Sales||373,396.00|
|DPO||Average Accounts Payable / (Cost of Sales/365)||42.78|
|Cash Conversion Cycle||3.84|