Most manufacturing and retail businesses have inventory which is used to make a final sale and turn a profit. Companies purchase inventory with cash and then turn the inventory into a product which is then sold for cash. The process of turning cash to cash is referred to as the Cash Conversion Cycle (CCC). In general, the faster the process the more efficient the operation, as less capital is tied up in operations. In laymen terms the CCC is a measure of how long it takes for a company to recover its investment in inventory.
Review the calculation for the cash conversion cycle. The equation is: CCC = DIO + DSO + DPO. The answer is given in days.
Determine DIO. DIO represents days inventory outstanding or the number of days inventory has been on the books.The calculation is: DIO = Average inventory/COGS per day and Average Inventory = (beginning inventory + ending inventory)/2. Inventory can be found on the balance sheet and COGS (cost of goods sold) can be found on the income statement.
Determine DSO. DSO represents days sales outstanding (how long it takes your customers to pay you). The calculation for DSO is: DSO = Average Accounts Receivable (AR) / Revenue per day and Average AR= (beginning AR + ending AR)/2. You can find AR on the balance sheet.
Determine DPO. DPO represents days payable outstanding (how long it takes you to pay your vendors). The calculation is: DPO = Average AP / COGS per day and Average AP = (beginning AP + ending AP)/2.
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