Previously, we defined Cash Conversion Cycle as the period between investments in and recovery
from the operating cycle of the company.
Here, we go deeper in description of Cash Conversion Cycle
and explanation how its length differs from the length of the Operating Cycle.
Operating cycle encompasses following stages:
Procurement
Payment
Processing
Sale
and Collection
Note, that there is no cash activity at the procurement stage:
company receives raw materials, but does not pay on spot experiencing the delay in payment.
Therefore, the payment stage outstands slightly forward in time.
That gap explains the nature of Accounts Payable.
After the purchasing, materials move to the processing,
finished goods passage to the warehouse and get delivered to clients.
We can see that the company carries inventory in different forms from Procurement until
Sales stage.
Finally, the gap between delivery to the client (we call it Sales) and Money Collection is
a background for Accounts Receivable.
We can see that operating cycle starts at the Procurement stage and ends at the Sales.
While Cash Conversion Cycle starts at Payment
and ends at Collection.
Both time-measured, those cycles can differ from each other.
The practical way to calculate the Cash Conversion Cycle is to identify each of three components:
take inventory turnover period (here we call it Days Inventory in Stock)
without accounts payable turnover period (we call it Days of Payables Outstanding)
plus accounts payable turnover period (in our case � Days of Sales Outstanding).
Please, choose to proceed to calculation of the certain cash conversion cycle component.