Cash conversion cycle

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Definition

Cash conversion cycle is the time duration in which a firm is able to convert its resources into cash. It is actually the total time period required to first convert resources into inventories, then inventories into finished goods, and then goods into sales. Here the resource may include raw material, labour, power and fuel etc. In other words it can be defined as the time taken to collect cash from sale of the after making payments for resources acquired by the firm. It should be noted that in many cases, sales doesn’t immediately convert into cash and acquisition of resources also doesn’t immediately convert into cash payments, so the difference should be taken between the actual cash collection and payment.

Calculation of cash conversion cycle

Cash conversion cycle can be calculated as follows

Cash conversion cycle = Inventory conversion period (in days) + Debtors’ conversion period (in days) - Creditors’ deferral period (in days)

Where

Inventory conversion period = Raw material conversion period (RMCP) + Work-in-progress conversion period (WIPCP) + Finished goods conversion period (FGCP)

              Where
              RMCP = Raw material inventory / (Raw material consumption/360)
              WIPCP = Work-in-progress inventory / (cost of production*/360)
              FGCP = Finished goods inventory / (cost of goods sold*/360)

Debtors’ conversion period = Debtors / (credit sales / 360)

Creditors’ deferral period = Creditors / (credit purchases/360)

[edit] External links

• ACCOUNTING TURNOVER RATIOS AND CASH CONVERSION CYCLE
• The Cash Conversion Cycle and Liquidity Analysis of the Food Industry in Greece
• Measuring the Cash Conversion Cycle in an International Supply Chain