cash-conversion cycle

Term of the Week: Cash-Conversion Cycle

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The speed at which a company can convert its expenditures back into cash is known as its cash-conversion cycle. Before you first opened your doors for business, you probably spent some money on things to get the company started, such as equipment, supplies, raw materials, and the like. You may have borrowed the money to make those purchases or used credit.

Since you can’t repay your vendors and lenders with the potential profit on the sale of your wares, eventually you will need to take an order, fill it, deliver it, and collect on the invoice so that you have the cash on hand to pay off your debt. Sounds simple enough but, during some months, it seems like it takes forever for that cycle to run its course.

The formula for cash-conversion cycles is the days inventories outstanding (DIO) plus the days sales outstanding (DSO) minus the days payables outstanding (DPO). These components are easy to calculate by simply referring to your most recent financial statements—typically, for a 12-month reporting period ending not longer than 30 days ago. You should be able to acquire this information from your accountant or accounting software, assuming accurate entries have been made into your general ledger.

Source: Vince DiCecco