The cash to cash cycle (cash conversion cycle) is an easy to use metric to calculate how long cash is tied up in the main cash producing and cash consuming areas: receivables, payables and inventory.
The Cash to Cash Cycle = Receivable Days + Inventory Days - Payable Days. Generally, the lower number to better.
Cash to Cash Cycle Calculation
Calculation is done from period financial reports in a three step process:
Step 1 - Calculate Sales per day and Cost of Goods Sold (CGS) per day
Sales per day on an annualized basis = Quarterly Sales X 4 ÷ 365.
CGS per day on an annualized basis = Quarterly Cost of Goods Sold X 4 ÷ 365.
Step 2 - Calculate Component Days
Receivable Days = Average Receivables for the Quarter ÷ Sales per day
Inventory Days = Average Inventory for the Quarter ÷ CGS per day
Payable Days = Average Accounts Payable for the Quarter ÷ CGS per day.
The results are show as whole numbers.
Step 3 - Calculate the Cash to Cash Cycle
Cash to Cash = Receivable Days + Inventory Days - Payable Days
Commentary
The cash to cash cycle is indicative of the business model a company chooses to use and their effectiveness at executing the model.
Dell is commonly used as the example for an extremely effective cash to cash cycle and consistently has a negative cash to cash cycle. For the quarter ending October 31, 2008, Dell had a cash to cash cycle as follows:
Receivable Days 36
plus
Inventory Days 8
minus
Payable Days (69)
Cash to Cash Days (25)
Cash to cash tracking can be done between different companies in the same industry segment or for different periods in time to both understand the dynamics of the business and to assess opportunities for improvement.
Normally, the lower the Cash to Cash Days, the better, but too low days in inventory can indicate service issues if the inventory is not properly planned and managed and very high days in payables may result in issues with suppliers.
