Final Lecture CCC

The cash conversion cycle (CCC) is one of several measures of
management effectiveness. It measures how fast a company

can convert cash on hand into even more cash on hand.
The CCC does this by following the cash as it is first

converted into inventory and accounts payable (AP), through
sales and accounts receivable (AR), and then back into cash.
Generally, the lower this number is, the better for the
company.
Although it should be combined with other metrics (such

as return on equity and return on assets), it can be especially
useful for comparing close competitors, because the company
with the lowest CCC is often the one with better management.
In this presentation, we'll explain how CCC works and show
you how to use it to evaluate potential investments.
 The Calculation
To calculate CCC, you need several items from the
financial statements:
Revenue and cost of goods sold (COGS) from the
income statement;
 Inventory at the beginning and end of the time period;
 AR at the beginning and end of the time period;
 AP at the beginning and end of the time period; and
 The number of days in the period (year = 365 days,
quarter = 90).
 Now that you have some background on what goes
into calculating CCC, let's look at the formula:
CCC = DIO + DSO - DPO
 DSO is a measure of how long it takes a
company to collect on it’s accounts
receivable(AR). The higher the DSO, the slower
the collecting – that’s a bad thing. The faster
the company can collect, the more options for
the company such as investing in more
inventory to turn into sales.
 The formula for DSO is (AVERAGE Accounts
Receivable / Credit Sales (REVENUE)) * 365
 Credit sales (purchases made by a consumer that do not require
a payment made in full at the time of purchase).
 Average AR = (beginning AR + ending AR)/2
Days Payable Outstanding
the average number of days a company takes to pay
its creditors(suppliers)
 The formula for DPO is (AVERAGE Accounts Payable /

COGS ) * 365
Average AP = (beginning AP + ending AP)/2
For this example, we'll use Microsoft's 2007 annual
report. The company lists its accounts payable as
$3,247 and its cost of goods sales as $10,693
(numbers in millions). So the math looks like
this:$3,247 (accounts payable)divided by $10,693
(cost of sales)= 0.304.Multiply 0.304 by 365, and you
get 110.96. This means that on average, it took
Microsoft 111 days to pay its creditors in 2007.
Generally, a larger number is better
when it comes to days payable; the
longer a company holds on to its money
before paying its bills, the longer that
money can sit in the bank earning
interest for the company. Of course, this
is only true if the company does
eventually pay its bills!
 DIO is a measure of how long it takes
for a company’s inventory to turn into
sales. The shorter the better because
the company carries less inventory and
hence less cash is tied up.
 The formula for DIO is (AVERAGE In
 ventory / COGS ) * 365
Average Inventory = (beginning inventory + ending inventory)/2
 Let's use a fictional example to work through. The data
below is from a fictional retailer Company X's financial
statements. All numbers are in millions of dollars.
 Item Fiscal Year 2013 Fiscal Year 2012

 Revenue 9,000 Not needed
 COGS 3,000 Not needed
 Inventory 1,000 2,000
 A/R 100 90
 A/P 800 900
 Average Inventory (1,000 + 2,000) / 2 = 1,500
 Average AR (100 + 90) / 2 = 95
 Average AP (800 + 900) / 2 = 850
Now, using the above formulas, CCC is calculated:

 DIO = 1,500 /3000 (365 days) = 182.5 days
DSO = 95/ 9000(365 days) = 3.9 days
DPO = 850 / 3000(365 days) = 103.4 days
CCC = 182.5 + 3.9 - 103.4 = 83 days
Calculate the CCC for company A and B given the below data. Which •
one is the best? Please note, the companies operates 240 days a
year.
Company A Company B
Item Fiscal Year 2015 Fiscal Year 2014 Fiscal Year 2015 Fiscal Year 2014
Reven 7000 12000 7500 8200

ue
COG 6000 6000 5500 4500
S
Inven 3000 1500 3200 1700
tory
A/R 120 160 200 150
A/P 1200 800 1500 800

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The cash conversion cycle (CCC) is one of several measures of

management effectiveness. It measures how fast a company

The CCC does this by following the cash as it is first

Although it should be combined with other metrics (such

 The formula for DPO is (AVERAGE Accounts Payable /

 Item Fiscal Year 2013 Fiscal Year 2012

Reven 7000 12000 7500 8200

A/P 1200 800 1500 800

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