Cash Conversion Cycle: Meaning, Interpretation, and Sample Excel Calculations for Target and Costco

The Cash Conversion Cycle (CCC) tells you how long it takes a company, on average, to convert its Inventory into cash after selling and delivering it, collecting the cash from sales to customers, and paying its suppliers in cash.

The formula is based on the Days Inventory Outstanding (DIO), Days Sales Outstanding (DSO), and Days Payable Outstanding (DPO): Cash Conversion Cycle = DIO + DSO – DPO.

Cash Conversion Cycle Definition: The Cash Conversion Cycle (CCC) tells you how long it takes a company, on average, to convert its Inventory into cash after selling and delivering it, collecting the cash from sales to customers, and paying its suppliers in cash.

The formula is based on the Days Inventory Outstanding, Days Sales Outstanding, and Days Payable Outstanding:

Cash Conversion Cycle Formula

The Cash Conversion Cycle is most relevant for Inventory-dependent companies such as retailers since they always follow a similar “cycle”:

1) Buy Inventory upfront and turn it into finished products.

2) Sell and deliver the products to customers

3) Collect the Cash from customers.

4) Pay the suppliers that provided the raw materials and other parts (they normally send invoices and require payments within a certain number of days).

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For example, if it takes 45 days to sell the Inventory, 30 days to collect the Cash from customers, and 40 days to pay the suppliers, the CCC is 35 days:

Cash Conversion Cycle Example

You rarely use the CCC directly in financial models or valuations; it’s more of a benchmarking tool to evaluate similar companies and diagnose potential problems.

It’s most useful when analyzing startups, small businesses, or distressed companies that might have a “cash crunch” due to policies around receivables collections, payments to suppliers, or inventory turnover.

In these cases, the CCC might affect a company’s financing needs – especially short-term financing via a Revolver or Inventory Loan.

So, while the Cash Conversion Cycle is unlikely to appear in traditional investment banking models, it could come up in a Debt vs. Equity model or other credit analysis.

Files & Resources:

Target vs. Costco – Excel Calculations (XL)

Target – Key Financial Statement Extracts (PDF)

Costco – Key Financial Statement Extracts (PDF)

Slide Presentation Used in Video (PDF)

Video Table of Contents:

0:00: Introduction
3:49: Part 1: CCC Calculations for Target and Costco
6:50: Part 2: Valuation Impact
8:30: Part 3: When is the Cash Conversion Cycle Useful?
9:55: Recap and Summary

How to Calculate the Cash Conversion Cycle for Target and Costco

The calculations are straightforward if you have the companies’ financial statements from the past several years.

You can start by calculating the Average Accounts Receivable, Average Inventory, and Average Accounts Payable in each period, as shown below:

Average Receivables Calculations

Then, calculate the Days Sales Outstanding, Days Inventory Outstanding, and Days Payable Outstanding based on these formulas:

Days Sales Outstanding (DSO) = Average Receivables / Revenue in Period * Days in Period

Days Inventory Outstanding (DIO) = Average Inventory / COGS in Period * Days in Period

Days Payable Outstanding (DPO) = Average Payables / COGS in Period * Days in Period

Once you have these, add the DSO and DIO and subtract the DPO:

Cash Conversion Cycle Formula with DSO, DIO, and DPO

The main point is to be careful with the periods.

So, if you’re using quarterly figures for Revenue and COGS, make sure you use 90 for the days in the period, and if you’re using annual figures, use 365 days (or 366 for leap years).

Both Target and Costco have very low Cash Conversion Cycles, indicating high efficiency. Sometimes, they even turn negative:

Cash Conversion Cycles for Target vs. Costco

Costco also trades at higher valuation multiples than Target in this example (see below), but it’s highly unlikely that the Cash Conversion Cycle is the root cause since both companies have very similar CCCs.

What Does a Negative Cash Conversion Cycle Mean?

As shown above, a negative Cash Conversion Cycle means the company sells Inventory and collects Cash from customers faster than it pays its suppliers.

This is usually viewed as very positive because it means the company is managing its operations efficiently and “forcing” the suppliers to wait on payments before it pays the invoices in Cash.

Negative CCCs are common for large retailers with significant pricing and market power (e.g., Amazon), as they cycle through their Inventory and collect Cash quickly while paying their suppliers more slowly.

The Cash Conversion Cycle and Its Valuation Impact

The Cash Conversion Cycle affects a company’s Change in Working Capital, which is a component of Free Cash Flow.

But for most companies, this Change in Working Capital is not a major value driver; it may shift the numbers slightly, but it’s more of a supplemental item.

So, higher or lower Cash Conversion Cycles alone are unlikely to drive valuation multiples.

If Working Capital is more significant for a company, the Cash Conversion Cycle could affect its Free Cash Flow and Free Cash Flow Conversion (i.e., FCF / EBITDA).

For example, one company you’re analyzing might have a lower CCC than the other due to faster sales of Inventory, faster Receivables collection, or slower Payables processing.

These lower Cash Conversion Cycles might result in more EBITDA being “converted” into Free Cash Flow.

In theory, higher Free Cash Flow should increase the company’s implied value in a DCF model (for example).

While this scenario is possible, it is far-fetched because many other factors affect valuation more than these timing differences.

For example, the companies’ revenue growth rates, profit margins, margin expansion, and “capital intensity” (i.e., the amount of Capital Expenditures required to grow) affect valuation via comparable company analysis more than the CCC.

If we return to the Target and Costco example, it’s highly unlikely that the Cash Conversion Cycle affects anything because both companies have similar numbers but trade at different multiples:

Target vs. Costco - Valuation Multiples

When is the Cash Conversion Cycle Useful?

In real-life financial models, the CCC is useful in two main scenarios:

Scenario #1: For small businesses and startups that depend heavily on Inventory, the CCC can be useful because it may indicate a looming “Cash crunch” and the need for the company to raise capital soon.

Scenario #2: The CCC can also be useful for distressed companies facing a Cash shortfall – but for slightly different reasons.

These companies often find it difficult to collect Cash from customers, and sometimes suppliers “squeeze them” by imposing unfavorable payment terms.

This can create a “vicious cycle” where the company must keep borrowing or raising capital to survive its standard Inventory à Collection à Payment cycle.

As a simple example, consider the two companies shown below:

Smaller Companies - Cash Conversion Cycle Comparison

They look similar, but the “Healthy Company” maintains its Cash Conversion Cycle in a range of 25 – 30 days over time.

Meanwhile, the “Stagnant/Troubled Company” lets its Cash Conversion Cycle creep up to 63 days, more than doubling over this time frame.

As a result, the second company’s Cash Flow from Operations and Free Cash Flow are significantly lower than the first company’s by Year 6, even though its core business has grown.

This company doesn’t necessarily need to raise capital because of these unfavorable trends, but they are a cause for concern.

As a result, this company will have less to re-invest in its business and grow its operations.

That said, this is still an artificial example because it’s highly unlikely that two companies would have the same financial profile over 6 years except for their Working Capital management.

About Brian DeChesare

Brian DeChesare is the Founder of Mergers & Inquisitions and Breaking Into Wall Street. In his spare time, he enjoys lifting weights, running, traveling, obsessively watching TV shows, and defeating Sauron.