Cash Cycle | B2B Finance Glossary

What is a Cash Cycle?

A cash cycle, also known as an AR cash cycle or cash conversion cycle (CCC), is a metric that shows the number of days it takes for a company to convert the investments it has made in its inventory, raw materials, and other resources into actual cash flow that comes in from sales. The cash cycle measures how long each net input dollar is tied up in the production and sales process before converting it into revenue.

Why is the Cash Cycle Important?

The cash cycle is important because it shows how efficiently a company operates and considers the time required to sell inventory, collect receivables, and pay outstanding bills.

Steadily decreasing CCC (i.e., a cycle that gets increasingly shorter) is a good indicator, while steadily rising CCC (i.e., a cycle that keeps getting longer) can indicate poor management or stagnating operations. It’s important to remember that the precise length of a good CCC varies across different industries, and comparing a company’s CCC to its competitors’ CCCs can reveal how that specific company’s cycle looks against the industry standard.

Additionally, CCC is a measure of liquidity: it shows how easily an unfinished product can be turned into cash.

How is the Cash Cycle Calculated?

Here’s the formula for calculating the Cash Conversion Cycle:

CCC = Days Inventory Outstanding + Days Sales Outstanding - Days Payables Outstanding

Days Inventory Outstanding (DIO) is the average number of days a company takes to turn its inventory into sales. Here’s the formula for Days Inventory Outstanding:

DIO = Average Inventory/Cost of Goods Sold X 365

Days Sales Outstanding (DSO) is the average number of days a company takes to collect its receivables. Here’s the formula for Days Sales Outstanding:

DSO = Average Accounts Receivable/Total Credit Sales X 365

Days Payables Outstanding (DPO) is the number of days, on average, it takes a company to pay back its payables (i.e., invoices from suppliers). Here’s the formula for Days Payables Outstanding:

DPO = Average Accounts Payable/Cost of Goods Sold X 365

How Does Your Cash Cycle Impact Your Business?

Inventory management, sales, and payables are all vital to the success of your business. If any of these categories is operating in a less-than-optimal way, your business is set to take a severe hit. Therefore, CCC is important because it accounts for monetary value and time – namely, the time needed to conduct inventory management, sales, and payables properly.

A long CCC can be caused by extended DSO periods, too much inventory, or paying expenses too quickly. As a result, companies with extended CCCs are at higher risk for insolvency. To shorten your CCC, it’s crucial to reduce DSO, more accurately predict your inventory needs, and slow down the time your finance team takes to pay your company’s bills.

Remember that, as a metric, CCC is important because it reveals how efficiently your company uses its short-term assets and liabilities to generate and redeploy revenue. It can also be used to show how healthy your business is regarding cash management and assess any liquidity risks associated with your operations.

Tips for Accelerating and Digitizing Your Cash Cycle

If you’re looking to speed up your CCC, a good option is to turn to new technological solutions that can help you digitize the enterprise cash cycle. Paystand was designed to help you reduce your DSO by offering tools that allow you to collect your receivables more quickly: autopay, embedded payment links attached to email invoices, and digital payment options that eliminate the need for paper check payments.

Additionally, while most companies turn to credit card payments to speed up their time to cash, they drain 3.5% of their revenue in merchant fees. Paystand offers zero-fee bank-to-bank payment options that eliminate the need for manual and paper-based processes while removing punitive credit card fees for good. In this way, your business can speed up its CCC without sacrificing revenue.

Finally, Paystand offers Smart Lockbox, a serious upgrade to traditional lockbox services. Smart Lockbox completely digitizes the cash cycle from payer to merchant and eliminates the need for paper check payments for good. With this product, your finance team can forget about spending time driving to the bank to pick up paper checks, get immediate visibility into the cash flow through payment data displayed as it comes in, a centralized collections process, and reduced receivables risk with 24/7 payment tracking, and check information, reconciliation status, and transaction details that are fully integrated into your trusted ERP system.