Can someone help explain the difference between the Operating Cycle vs the Cash Conversion Cycle.
As I understand it, and based on definitions:
Operating Cycle = days of inventory + days of receivables
so, you spent $100 on inventory, it sits there for 20 days average until you sell the product, at which point it takes average of 10 days to collect cash. So the O.C. is 20 + 10 = 30 days. Is that right?
Cash Conversion Cycle:
C.C.C.= avg days of receivables + avg days of inventory - average days of payables
So using the same example, its the same but you take off the avg days of payables. But what is that telling you exactly? So say, it takes you 5 days average to pay your supplier, the CCC is 30 - 5 = 25. What’s the insight here exactly and what extra useful info are we getting to the O.C. calculated above.
Your calculations appear correct to me. I look at the operating cycle and the CCC in terms of working capital. Operating cycle requires funding. The shorter the better/ cheaper. However, you don’t have to fund the full operating cycle if your suppliers provide you with some credit (via payables). The CCC therefore is a more accurate measure of the typical funding requirements of selling goods.
I hope is clear and helps. Paul
Thanks Paul, I think I get it. So the OC tells you the period of time where funding is going to be required by somone (you or the supplier), whereas the OCC tells you the period of time that YOU are going to have to provide the funding (i.e. 30 days O.C., of which 5 days the supplier can fund, leaving 25 days of which YOU have to fund). Let me know if you interpret this differently.
The Cash Conversion Cycle is basically a depiction of the actual cash position by equating the cash flowing in and the cash flowing out in buying inventory, selling inventory, collecting cash from customers and actually paying your suppliers. Operating Cycle assumes that you have paid the supplier at the time of purchases and neglects the credit period that suppliers provide their customers.