Invoice Bazaar Blog

What is Cash Conversion Cycle and why it is important?

By Invoice Bazaar | October 21, 2020

The Cash Conversion Cycle (CCC), which is also called the Net Operating Cycle or only as Cash Cycle, refers to the total number of days it usually takes for a business enterprise to buy raw materials, convert them into finished products, sell them and receive payment from the customers. In other words, it represents the time between the buying of raw materials to turning them into finished products and collecting the money from the sale of those products.

Therefore, the Cash Cycle indicates the length of time (measured in days) that the working capital remains tied up in the production and sales process until it gets converted into cash receipts. CCC is thus an important financial yardstick that enables the business owner to determine the efficiency at which her business venture transforms the raw materials into sales and then into cash. Furthermore, Cash Cycle is a crucial metric that serves as one of the quantitative measures for calculating and evaluating a firm’s efficiency in managing its working capital.

The Cash Cycle and its monitoring are important for several reasons. Small and medium enterprises (SMEs) that want to keep growing while sustaining or improving their profit margins should not only calculate and track their cash conversion cycle but also strive to shorten it or lower it. That is because a shorter or lower Cash Cycle indicates that your business unit is proficient at converting raw materials into cash, and confirms it is operating efficiently.

Investors, bankers and creditors study or analyse the Cash Cycle to assess the financial health and liquidity of a business unit. The shorter a business unit’s cash cycle is, the better as it indicates that the working capital is not getting tied up for long and it has higher liquidity. The greater the liquidity of a company, the more easily it can invest in growth, repay its loans and settle other financial obligations and commitments. Similarly, suppliers may also look at your firm’s CCC before deciding whether or not to extend you credit.