
D-POPS GROUP is a community of enterprises that combine “real business, technology, and group synergy” in their operations, aiming to realize a Venture Ecosystem that remains essential to society even 100 years from now. In this article, we will explain the cash conversion cycle (“CCC” from here on).
1. What is the Cash Conversion Cycle (CCC)?
CCC is a financial metric that indicates the period of time from when a company spends cash to procure raw materials or goods until it sells those goods or services and that cash gets returned to them.
The CCC is an indicator of how much funding a business requires (working capital). The shorter the period, the less working capital is needed, and the more efficient the business is. In other words, a shorter CCC means less required working capital, faster business growth, increased surplus funds available for business growth investment, and minimization of financing needs.
To get straight to the point, the amount of working capital a business requires depends on the duration of the CCC. For example, in a somewhat simplified case, the required working capital for a business that spends 10 million yen per month on procuring raw materials or goods is only 10 million yen if the CCC is 1 month (10 million yen multiplied by a 1-month CCC); but it’s 20 million yen if the CCC is 2 months (10 million yen multiplied by a 2-month CCC).
If this business grows and procurement costs become 20 million yen per month, then the required working capital increases by 10 million yen (to 20 million yen) if the CCC is 1 month, and by 20 million yen (to 40 million yen) if the CCC is 2 months.
Assuming a monthly operating profit of 1 million yen, profit retention required for working capital would be 10 months’ worth of profit if the CCC is 1 month, but 20 months’ worth of profit if the CCC is 2 months.
As you can plainly see, CCC is a critical metric for business growth speed, increasing surplus funds for business growth investment, and minimizing financing.
2. How to Calculate the CCC
Here, we will explain the details of how to calculate the CCC.
Basically, the CCC is calculated by combining the following three elements:
CCC = days sales outstanding + days inventory outstanding - days payable outstanding
Days sales outstanding (DSO)
The average number of days it takes to collect payment after selling goods or services. For example, contracts often stipulate payment at the end of the next month after the month of sale, in which case the DSO is the number of days in that specific month (30, 31, etc.). For retail businesses that only accept cash payments, the DSO is 0 days. Recently, with the spread of cashless payments like credit cards and electronic money, the DSO in retail may also be lengthening depending on the payment settlement cycle of the cashless payment companies.
Days inventory outstanding (DIO)
The average number of days from when raw materials or goods are procured, processed, and stored as inventory, until they are finally sold.
Days payable outstanding (DPO)
The average number of days from when raw materials or goods are procured until payment is made to the supplier. Similar to DSO, if the contract requires payment at the end of the next month after the month of procurement, the DPO will be the number of days in that specific month (30, 31, etc.).
Theoretically speaking, these above definitions are true, but it becomes quite difficult in practice to calculate the average days using a weighted average based on transaction amounts when dealing with many suppliers.
Therefore, the average days are calculated more practically using the following formulas:
Days sales outstanding = accounts receivable ∕ (annual sales ∕ 365 days)
Days inventory outstanding = inventory ∕ (annual sales ∕ 365 days)
Days payable outstanding = accounts payable ∕ (annual sales ∕ 365 days)
Since (annual sales ∕ 365 days) is simply a calculation of daily sales, (monthly sales ∕ # of days in the month) can also be used in the above formulas as a replacement.
Furthermore, as the above formulas calculate each turnover in relation to daily sales, multiplying the CCC by the daily sales allows us to calculate the required working capital for the business:
Required working capital = CCC ✕ (annual sales ∕ 365 days)
3. How to Shorten the CCC
So, how can we shorten the cash conversion cycle?
While it is not easy to control the days sales outstanding, days inventory outstanding, and days payable outstanding, in the world of retail, it is still possible to control the days inventory outstanding through a company’s concerted efforts.
If we rearrange the previous formula for days inventory outstanding, we get the following:
| DIO | = | (inventory ÷ annual sales) ✕ 365 days |
| = | (1 ÷ annual sales ÷ inventory) ✕ 365 days | |
| = | (1 ÷ inventory turnover rate) ✕ 365 days |
This shows that days inventory outstanding is inversely related to inventory turnover rate.
Therefore, the higher the inventory turnover rate, the shorter the days inventory outstanding will be.
You can see how this article on CCC is related to our article written by Senior Managing Director Watanabe, “Inventory Turnover: The Retail Industry’s Hidden Platform”. If you want to know how to increase the inventory turnover rate—in other words, how to shorten the days inventory outstanding—be sure to read it.
Now, the consumer electronics retailer mentioned in that article, which we called Company B, had an inventory turnover rate of 18 times per year, so the days inventory outstanding is calculated as follows:
| DIO | = | (1 ÷ inventory turnover rate) ✕ 365 days |
| = | (1 ÷ 18) ✕ 365 days | |
| ≈ | 20 days |
What is important here is that the days payable outstanding (the so-called payment cycle) for most consumer electronics retailers is said to be 60 days or more. This is believed to be based on strong negotiation power stemming from the fact that consumer electronics retailers are a critically important sales channel for manufacturers. However, if we assume for the moment that this consumer electronics retailer only accepts cash payments, meaning the days sales outstanding are 0, the CCC is calculated as follows:
| CCC | = | DSO (0 days) + DIO (20 days) - DPO (60 days) |
| = | −40 days |
The result is negative 40 days.
A CCC of negative 40 days means that the required working capital is negative, implying that working capital is unnecessary for business growth, surplus funds for business growth investment will increase, and financing will be minimized.
Since Company B, the consumer electronics retailer, is set with annual sales of 750 billion yen, the amount of surplus funds is calculated as follows:
| Surplus funds | = | CCC ✕ (annual sales ÷ 365 days) |
| = | −40 days ✕ (750 billion yen ÷ 365 days) | |
| ≈ | 82 billion yen |
This means that not only is working capital unnecessary for business growth, but approximately 10% of annual sales is secured as surplus funds, separate from retained earnings.
While negotiating the days payable outstanding (the so-called payment cycle) requires strong negotiation power with suppliers and is difficult to control in the short term, it remains a vital factor for reducing the required working capital and accelerating business growth.
The drugstore industry has also achieved not only lower procurement prices but also an extension of the days payable outstanding (i.e., payment cycle) by leveraging strong negotiation power based on continuously growing sales volume. This has been a factor enabling accelerated store expansion. Generally, the days payable outstanding (i.e., payment cycle) for drugstores is said to be 60 to 90 days or more. Furthermore, many drugstores build their logistics networks in partnership with specialized wholesalers, systematically achieving a shorter inventory turnover rate (in other words, a smaller number of days inventory outstanding), which also contributes to a shorter CCC.
4. Summary
In this article, we have explained the Cash Conversion Cycle (CCC). Although we used many examples from the retail industry, the essence of the CCC is how long it takes for funds spent (essentially, invested) in the business to be recovered. By calculating this based on sales, you can figure out the amount of funds required for operations (i.e., working capital). Therefore, we believe that with a little ingenuity, the CCC is an important metric that can be applied to all industries, not just retail, and can provide a company with many insights.
For example, by calculating the turnover period for liabilities related to selling, general, and administrative expenses and incorporating it into the CCC, the applicable industries can be broadened, and more insights can be gained. Moreover, by incorporating the payback period for customer acquisition cost (CAC) into the CCC, it can also be applied to the SaaS model.
As Peter Drucker once said, “What gets measured gets managed”, so we hope that calculating your company’s CCC will serve as a reference point for focusing attention on your required working capital.
Finally, as Kazuo Inamori wrote in Practical Learning of Management and Accounting, while profit is a very important metric, cash flow is the essence and an even more critical indicator. Modern accounting, with its accrual basis, is highly sophisticated and complex. The CCC is a crucial calculation and tool for business growth in accurately capturing the cash flow that has become less visible, and for practicing cash flow management.
We hope that you learned something from this article and look forward to working with you in the future.
D-POPS GROUP Executive Officer, President’s Office Head
Yoshihiro Yoneya
