What Is Cash Flow Conversion? (2024)

FAQs

What Is Cash Flow Conversion? ›

The cash flow conversion ratio is a one-step calculation measuring your business's efficiency in turning sales into cash. It's a liquidity ratio comparing operating profits and free cash flow over the period in question.

Free Cash Flow Conversion is a liquidity ratio that measures a company's ability to convert its operating profits into free cash flow (FCF) in a given period. By comparing a company's available free cash flow to an operating metric, the FCF conversion rate helps evaluate the quality of a company's cash flow generation.

What Is Considered a "Good" Cash Conversion Ratio? Depending on the particular industry your enterprise is in, a good CCR will differ. In general, however, a CCR of 1 indicates that a business efficiently converts every dollar of net income to cash.

The cash conversion ratio, often abbreviated as “CCR” for brevity, reflects the proportion of the net profit generated by a company that becomes operating cash flow (OCF). The cash conversion ratio compares the reported net income of a company to its cash flow from operations (CFO) in a specified period.

The formula for calculating the cash conversion cycle sums up the days inventory outstanding and days sales outstanding, and then subtracts the days payable outstanding.

Example of the Cash Conversion Cycle

DIO = ($1,500 / $3,000) x 365 days = 182.5 days. DSO = ($95 / $9,000) x 365 days = 3.9 days. DPO = $850 / ($3,000 / 365 days) = 103.4 days. CCC = 182.5 + 3.9 - 103.4 = 83 days.

The cash cycle, or cash conversion cycle, is the time it takes for a company to convert its investments in inventory into cash flow from sales. It's measured by adding days inventory outstanding to days sales outstanding and subtracting days payable outstanding.

If your business is operating at maximum efficiency, the cash flow conversion ratio would be one. That would show that you successfully convert every dollar of net income earned into cash. However, it's rare for a business to achieve this goal. In most cases, the result will be either higher or lower than one.

Once cash flow is determined, the next step is dividing it by the net profit. That is the profit after interest, tax, and amortization. Below is the cash conversion ratio formula. The resulting ratio from this calculation can be either a positive value or a negative value.

Following the 10% rule is another way to calculate the rate of average cash flow. Divide the yearly net cash flow by the amount of money that was invested in the property. If the result is over 10%. Then this is a sign of positive and a good amount of average cash flow".

What is the importance of cash conversion? ›

The shorter a company's CCC, the less time it has money tied up in accounts receivable and inventory. The cash cycle is an important working capital metric for all companies that buy and manage inventory. It's an indicator of operational efficiency, liquidity risk, and overall financial health.

A longer CCC means that it takes a longer time to generate cash, which can mean insolvency for small companies. When a company collects outstanding payments quickly, correctly forecasts inventory needs, or pays its bills slowly, it shortens the CCC. A shorter CCC means that the company is healthier.

The Cash Conversion Cycle (CCC) is a metric that shows the amount of time it takes a company to convert its investments in inventory to cash. The conversion cycle formula measures the amount of time, in days, it takes for a company to turn its resource inputs into cash.

CCC of less than 30 days is optimal as it indicates that the company quickly converts its investments in inventory and other resources into cash. CCC between 30 and 60 days is average and may indicate that there is room for improvement.

The CCR is equal to the cash flow from operations divided by the net profit. You can get these figures from your financial statements.

Cash Conversion Score is used by investors to measure the return on invested capital for startups. It is calculated by dividing current ARR by the difference between total raised capital and cash on hand. Essentially, this metric gives the return on each dollar invested in a company.

For example, one bond that can be converted to 20 shares of common stock has a 20-to-1 conversion ratio. The conversion ratio can also be found by taking the bond's par value, which is generally $1,000, and dividing it by the share price.