# What is Cash Conversion Cycle?

Cash conversion cycle (CCC) is used to evaluate the effectiveness of a company’s management in converting its current resources into actual cash received from customers in a transaction.

It gives us an idea on how money flows within the company. The money-flow comes in a few steps: 1) A company uses its own cash to buy inventory (normally under a credit term); 2) it then sells its inventory to customers; and 3) it waits to collect actual payment from customers.

Let us now break down the CCC mathematically.

The Formula

CCC is calculated using the formula below:

 CCC = Days Inventory Outstanding + Days of Sales Outstanding – Days Payable Outstanding

To better illustrate this term, we will look at the CCC of Dairy Farm International Holdings (SGX: D01) in 2012. Dairy Farm is one of the largest retail operators in Asia and it owns brands like Cold Storage, Giant and Guardian in Singapore.

Days Inventory Outstanding (DIO)

DIO is the number of days that it takes for a company to sell its entire inventory. Generally speaking, the lower the number of days, the more effective the company is at inventory management.

The formula for DIO is given below:

 DIO = Average Inventory / Cost of Goods Sold per day, where Average Inventory = (Beginning Inventory + Ending Inventory) / 2

 US\$ (million) Average 2012 2011 Inventory 953.8 958.4 949.1 COGS 19.1 (per day) 6,970.50 DIO 49.9

Source: Dairy Farm International Annual Report 2012 Data

Using Dairy Farm’s annual report for 2012, we can thus estimate its “DIO” to be around 49.9 days, as seen from the table above.

Days of Sales Outstanding (DSO)

DSO is the number of days it takes for a customer to pay the company after a sale is recorded.

Similar to DIO, having lower DSO usually indicates a company that is good at credit management.  Most retailers operate in a cash only basis (think of how you usually pay for goods at the supermarket using a credit card, debit card, or cash), therefore this number should be zero for them.

However, for other businesses that gives a credit term to its customers, DSO will be more than zero.

It is calculated using the formula:

 DSO = Average Account Receivable / Revenue per day, where Average Account Receivable = (Beginning Account Receivable + Ending Acccount Receivable) / 2

 US\$ (million) Average 2012 2011 Account Receivables 206.7 195.6 217.8 Revenue 26.9 (per day) 9800.6 DSO 7.7

Source: Dairy Farm International Annual Report 2012 Data

From the table above, we can see how Dairy Farm has a “DSO” of 7.7 days based upon our calculations.

Days Payable Outstanding (DPO)

Finally, we come to DPO, which is the number of days it takes a company to pay its suppliers after their products have arrived. In general, having a longer payment term is better for a company.

DPO’s formula is given by

 DPO = Average Account Payable / Cost of Goods Sold Per Day, where Average Account Payable = (Beginning Account Payable + Ending Account Payable)/2

 US\$ (million) Average 2012 2011 Account Payable 2207.9 2275.5 2140.2 Cost of Goods Sold 19.1 (per day) 6970.5 DPO 115.6

Source: Dairy Farm International Annual Report 2012 Data

Dairy Farm has a “days payable outstanding” of 115.6 days from our estimation.

In Summary

When we put it all together, Dairy Farm International has a cash conversion cycle of negative 58 days (49.9 + 7.7 – 115.6 = -58).  This means that Dairy Farm International does not require any working capital at all to operate its stores.

Meanwhile, it is also important for investors to look at how a company’s CCC has changed over the years.. This will give them a better sense of any changes in the cash management quality of the company, if any.