Cash conversion cycle
What is a cash conversion cycle?
A cash conversion cycle is a calculation of how long investing in resources will take to produce a cash flow. In other words, it's the measure of liquidity risk a company has when it grows its investment.
Where have you heard about cash conversion cycles?
If you deal with a company's accounts and inventory, you may have worked with cash conversion cycles. It's a common tool used by firms to calculate how long it's going to be before their inventory is cleared and paid back in cash.
What you need to know about cash conversion cycles.
To calculate a cash conversion cycle, you first work out the days inventory outstanding - how long it would take the company to sell the current inventory level.
Next, you calculate the days sales outstanding - the amount of time (usually in days) it takes to collect cash, or accounts receivable , from the sales of the inventory.
Finally, you work out how much the company owes vendors for inventory purchases using the days payable outstanding [link']. The bigger this number, the longer the company can hold onto its cash for.
To calculate the cash conversion cycle:
Days inventory outstanding + days sales outstanding - days payable outstanding
Find out more about cash conversion cycles.
A cash conversion cycle is a way of measuring a company's liquidity risk. Read our guide to liquidity risk here .