The cash conversion cycle provides information about how long it takes for businesses to convert their investments into cash. An efficient cash flow analysis is the key to measuring the success of any business. Also, knowing the Cash Conversion Cycle in the Manufacturing industry is very important because it can help you make more informed decisions. In this article, we have explained the Cash Conversion Cycle in Manufacturing in detail to create a better understanding. Knowing the calculation of the cash conversion cycle can help you to use the money for the most important operations.
Define Cash Conversion Cycle
The cash conversion cycle is the difference between the time when you invest money in your business and when you get the money in return for that investment. For example, you own an electrical shop. You have invested money on 10th October to buy 50 bulbs from your wholesaler.
- Let’s assume that you sold those 50 bulbs by 30th October.
- In this case, you invested on 10th October and got cash in return by 30th October.
- This means your cash conversion cycle is 20 days.
The shorter your cash conversion cycle, the more profit you can make for your business.
Cash Conversion Cycle In Manufacturing
If we look at the manufacturing process, it starts by placing orders for raw materials. Once it is received, the production starts to make a variety of goods. When the manufacturing process is done, the company has to sell their products in the market. Finally, they get money for their sales. In manufacturing businesses, investors may have to wait for a longer time to get profit in return for their investments. So, it is important to find out the Cash Conversion Cycle in Manufacturing because it usually takes a long time to convert investments into cash. The businesses track all the records from their investments in raw materials until they get payment for their sales. Being a manufacturer, you might also be doing the same and following a manual approach. If yes, then you must invest in some advanced software to run your business smoothly and increase profit while tracking all the important data in place.
Formula For The Cash Conversion Cycle For Manufacturing Companies
The Cash conversion cycle in manufacturing formula consists of three things;
- Days inventory outstanding (DIO)
- Days sales outstanding (DSO)
- Days payable outstanding (DPO)
Here, you need to separately calculate the value of DIO, DSO, and DPO. And then, you need to use these values in the CCC formula to get your final cash conversion cycle. CCC Formula = DIO + DSO - DPO In other words, Cash Conversion Cycle = Days Inventory Outstanding + Days Sales Outstanding - Days Payable Outstanding. This is the simple CCC formula that will help you calculate the cash conversion cycle for your manufacturing business. However, you may find it difficult to calculate DIO, DSO, and DPO. Therefore, we will explain specific formulas to calculate them separately. Let’s take a cash conversion cycle in manufacturing example to have a better understanding.
Step 1 - Days Inventory Outstanding (DIO)
DIO is calculated to know the average time it takes to turn your raw materials into finished goods. Let us assume that your average inventory value is Rs. 50,000 and the cost of goods sold (COGS) for 30 days is Rs. 100,000. Now, put in the values in the given formula. DIO (Days Inventory Outstanding) = (value of average inventory/cost of goods sold) × number of days Here, DIO = (50,000/100,000) × 30 = 15 It means it will take 15 days to convert your raw materials into finished goods.
Step 2 - Days Sales Outstanding (DSO)
DSO is calculated to know the average time it takes to receive payment for the products that you have sold. Using the DSO formula, you can analyse your accounts receivable and total credit sales for that specific time. Let’s say your accounts receivable are Rs. 50,000, and your total credit sales are Rs. 150,000 for the 30 days. Now, use the data in the formula to calculate your DSO. DSO (Days Sales Outstanding) = (accounts receivable/total credit sales) × number of days Here, DSO = (50,000/150,000) × 30 = 10. It means it will take an average of 10 days to collect your payment from your customers.
Step 3 - Days Payable Outstanding (DPO)
DPO is calculated to know how many days you take to pay your suppliers or vendors. Here, you will need to know your accounts payable value and cost of goods sold for a certain time. Let us say your accounts payable is Rs. 75,000, and the cost of goods sold is Rs. 150,000 for 30 days. Now, put the data in the formula to get your DPO. DPO (Days Payable Outstanding) = (accounts payable/cost of goods sold) × number of days Here, DPO = (75,000/150,000) × 30 = 15. It means you pay your suppliers for an average of 15 days.
Step 4 - Cash Conversion Cycle (CCC)
Now, you can calculate the Cash Conversion Cycle in Manufacturing by using the above-calculated data of DIO, DSO, and DPO in the CCC formula. CCC (Cash Conversion Cycle) = DIO + DSO - DPO Here, CCC = 15 + 10 - 15 = 10 It means you convert your investments into cash in an average of 10 days. The lower your cash conversion cycle, the more beneficial it is for your business. It is because when you get returns early, you can use the money for other important things to make more profit.
Cash Conversion Cycle with TranZact
The Cash Conversion Cycle in Manufacturing industry is important because many activities and processes are involved in production and you need cash for all of them. So, understanding the above-shared information would help you effortlessly manage your business. You can use TranZact to help you with working on your cash conversion cycle. It offers a one stop solution for inventory management, production analysis, and making other informed decisions for your business success. You can also ask us for the cash conversion cycle in manufacturing PDF to have a clear idea about your cash flows in simple ways.
FAQs
Q1. What is the cash conversion cycle, and why is it important for manufacturing business?
The cash conversion cycle figures out how long it takes for businesses to convert their invested amount into cash. Smartly managing the cash conversion cycle can help manufacturers to use their money for profitability.
Q2. What is the CCC Formula?
CCC, that is, Cash Conversion Cycle formula is below: CCC = DIO + DSO - DPO (or) Cash Conversion Cycle = Days Inventory Outstanding + Days Sales Outstanding - Days Payable Outstanding.
Q3. How to calculate the cash conversion cycle?
You have to separately calculate days inventory outstanding (DIO), days sales outstanding (DSO), and days payable outstanding (DPO). Then, use the data in the CCC formula.
Q4. How can a shorter cash conversion cycle benefit a manufacturing business?
The shorter cash conversion cycle means that cash is flowing faster. In this case, business owners can circulate the money for other important things and beneficial deals to expand their business and make more profit.
Q5. How can software help businesses calculate the cash conversion cycle?
Using the software, you will have better inventory management, sales tracking, managing accounts payable and receivable, and more, which are important factors while calculating the cash conversion cycle in manufacturing.
Q6. What does it mean by days inventory outstanding (DIO) in businesses?
Days inventory outstanding is calculated to know how many days it takes to transform raw materials into final products.
Q7. What does it mean by days sales outstanding (DSO) in manufacturing businesses?
Businesses calculate days sales outstanding to find out how many days it takes to collect payment from their customers.
Q8. What does it mean by days payable outstanding (DPO) in businesses?
Days payable outstanding provides insights into how many days it takes for businesses to pay their suppliers or vendors.
