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hey guys welcome to another video today i'll be teaching you how to measure the cash conversion cycle right so this is a subject that everybody loves cash how do we measure the cash conversion cycle for a company so we'll be jumping into my computer here and i'll be showing you an example for company a and company b so we can compare and contrast and see how do we get to the cash conversion cycle and as you can see here looking at the result for company a is 39 days and for company b is 66 days i'll teach you what that what that means how to interpret this result and which company is better off as well as the calculations so we'll be going through the calculation for uh days inventory outstanding day sales outstanding and days payable outstanding and then we'll put it all together to arrive at the cash conversion cycle being able to calculate the cash conversion cycle is a crucial skill if you're a financial analyst or an accountant so that's the topic of this video today stick around if you're new here welcome welcome my name is bill hannah i'm the financial controller i'm a licensed cpa in the great state of new york and i have over 15 years of experience in the field of finance what i started out at pricewaterhousecoopers as an auditor and then it transitioned out to private industry and then i worked my way up from a financial analyst position all the way up to a corporate controller position which is what i do today and this channel is all about giving you the summary or the juice of my experience over the last decade and a half and i do this here in the youtube channel as well as on my website through blog posts an online course and templates so go ahead and check that out as well all right so jumping right into today's topic so we said we'll be looking at an example for company a and company b and we'll be looking to calculate the cash conversion cycle so to calculate that we will need to calculate the day's inventory outstanding the day is sales outstanding and the days payable outstanding so i'll be showing you each one of these uh the definition and the formula for each one and then we'll calculate all these numbers to be able to put it all together and get to the cash conversion cycle for each company all right first a quick definition the cash conversion cycle measures the time which the company takes for converting its inventory and other inputs into cash and it considers the time that is required for selling the inventory the time required for collecting receivables and the time the company gets for paying its bills to its suppliers looking at the formula for the cash convergence cycle so the cash conversion cycle is uh taking the day's inventory outstanding or dio plus the day's sales outstanding or dso minus the days payable outstanding or dpo and in the next slides here we'll go through the calculation for each of these components and after we're done calculating this is the result that we'll be looking at so this is the result after everything that we will be doing today uh we'll be looking at these numbers here getting the dio dso and dpo for company a and for company b so this is just giving you a quick picture of the result before we dive into the calculation which we'll do here in a second all right let's break it down a little bit more so dio stands for the day's inventory outstanding and uh day's inventory outstanding uh signifies the total number of days taken for the company to convert the inventory into the finished product and completing the sales process so we're going to be adding that together with uh day sales outstanding or dso which is the average number of days the company takes to convert its accounts receivable um into cash and helps us determine how good a company uh is collecting its dues or its accounts receivable minus so be taking that and subtracting the dpo or the days payable outstanding which is the average time in days that a business takes to pay off its suppliers all right so let's go through the calculation one by one so for today's inventory outstanding we'll have a set of information for company a and for company b and the formula for uh day's inventory outstanding is going to be taking the inventory balance or the average inventory balance dividing it by the cost of sales and multiplying it by the number of days in a period and this period here happens to be a year so it's time 365. so looking at this information we have company a it has an inventory um three thousand dollars and cost of sales fifty four thousand company b five thousand and inventory and cost of sales is thirty three thousand so when we calculate that by using the formula here on top we get the following results so for company a we'll be looking at 3000 divided by 54 000 times 365 that will give us uh 20 days we do the same thing for company b we will get uh 55 days approximately and this is saying that this company company a it takes it 20 days to get its product completed or finished and uh being sold and completing the sales process while company b takes a little longer which is 55 days here so now that we've done that we've calculated the day's inventory outstanding we know now that company a is 20 days and company b is 55 days and this is the first component of calculating the cash conversion cycle that's why i put it all here in yellow because this is the only component that we've calculated so far which is days inventory outstanding so next we'll be going through dso and then dpo so we can calculate the full cash conversion cycle [Music] [Music] all right so looking at dave sales outstanding or dso we will have also a set of information for company e and company a and company b and the formula for dso is going to be taking accounts receivable balance dividing it by net credit sales and obviously credit sales uh exclude cash sales right so we're only looking at credit sales which is the sales that you make on credit that you're extending the credit to the customer and you'll be collecting say in 30 days 45 days or 60 days whatever the case may be times the number of days in the period which is 365 because we are measuring it for a year so in this example here we have company a accounts receivable is uh the balance at the end of the year is five thousand and the net credit sales for the year is forty thousand um for company b is six thousand and then fifty thousand for net credit sales and if we plug that into the formula here we'll get the following results so for company a we're looking at dividing five thousand from up here accounts receivable divided by net credit sales multiplied by 365 so we will get 46 days so this is here saying that it takes this company approximately 46 days to convert its accounts receivable into cash or sales into cash if you look for company b uh if you do the same calculation you will get 44 days so they are very similar in that aspect uh 46 days versus 44 days and by doing that now we calculated dso this is the second component that we need in order to be able to calculate the cash conversion cycle so uh now we've gotten dso 46 days versus 44 days and next we'll be looking at dpo so for dpo uh we also will be looking at company n company b and the formula for dbo or days payable outstanding takes accounts payable divided by cost of goods sales multiplied by 365 or the number of days in the period so in this example um we have company and company b accounts payable 4 000 for company a while it's 3 000 for company b and cost of sales here 54 000 versus 33 000. so we can plug that into the formula that we have right on top and get the following results for company a the dpo calculation will be 4 000 from right here divided by 54 000 which is cost of sales multiplied by 365 which is 27 days and for company b if you do the same calculation you will get 33 days which is saying that each of these companies for company a takes in 27 days approximately from incurring the cost uh of the product until they pay off the supplier so 27 days which is kind of on the on the small or the shorter end here usually a company will have between 60 and 90 days to pay his suppliers this here is a little bit short but now that we've calculated the dpo we can take it um and plug it here 27 days and 33 days and what we'll see now is that we have all three components dio dso and dpo we can go ahead and calculate the cash conversion cycle which we said is going to be taking a day's inventory outstanding um and add the dso their sales outstanding and then subtract the days payable outstanding when you do that for company a you get 39 days um you do that for company b you get 66 days which is saying that company a has a cash conversion cycle of 39 days which means they're better off they're able to manufacture the product or purchase the product put it all together complete the sales process collect the cash and pay off the supplier and all in 39 days while company b it takes them 66 days to do the same thing which is obviously they are not doing as great as company a in some cases what you'll see is that some companies if you look especially a publicly traded companies like apple they'll have a negative cash conversion cycle right that means that they have such a long time frame to pay their suppliers so that when you put that in the formula here which is a bigger dpo or this payable outstanding you'll get a negative cash conversion cycle which may seem like something bad or negative but actually a negative cash conversion cycle implies that you have such power over your supplier that you're able to have a much longer time frame to pay off your suppliers or to complete the cycle so so this is the calculation and the explanation for the cash conversion cycle if you liked it and you learned something new from it go ahead and smash that like button and go ahead and share it with a friend who you think might benefit from it and i'll see you in the next video [Music] you