The cash conversion cycle indicates the number of days that a company’s cash is tied up in the production and sales process of its operations. The shorter the cycle, the more liquid the company’s working capital is.
The higher the CCC, the longer it takes for the company to convert its inventory and credit sales into cash. An increase in the CCC could be an indication of one or all of the following:
- The company has a large amount of old or slow-moving inventory that eventually will need to be written off.
- The customers are not paying as quickly as they have done in the past. This could lead to an increase in the reserve for bad debt or possibly an expense for bad debt.
- Days payable outstanding has decreased as a result of the company paying its bills earlier than they have in the past.
Formula for Acid Test Ratio
CCC=Days in Inventory+Days Sales Outstanding-Days Payable Outstanding
ABC Company has currents days in inventory of 45 days, days sales outstanding of 48, and days payable outstanding of 30 days. This gives a cash conversation cycle (CCC) of 63 days.