The cash to cash cycle is the time period between when a business pays cash to its suppliers for inventory and receives cash from its customers. The concept is used to determine the amount of cash needed to fund ongoing operations, and is a key factor in estimating financing requirements. The cash to cash calculation is:
= Cash to cash days
For example, the inventory held by a business averages being on hand for 40 days, and its customers usually pay within 50 days. Offsetting these figures is an average payables period of 30 days. This results in the following cash to cash duration:
40 Days of inventory + 50 Days sales outstanding - 30 Days payables outstanding
= 60 Cash to cash days
This outcome states that a business must support its expenditures for a period of 60 days. Examination of the components of this calculation might lead management to take several offsetting actions, such as shrinking the amount of on-hand inventory, tightening credit to customers or requiring payment in advance, and negotiating longer payments terms with suppliers.
The calculation is especially useful under the following circumstances:
- Forecasting. When there are indications that payment or receipt intervals are likely to change, so that one can estimate the impact on cash.
- Recoveries. When attempting to recover a business from a bankruptcy situation, where cash is in short supply.
- Expensive debt. When the cost of debt is high, and management is looking for alternatives that will require less outside funding.
- Dividends. When investors want a dividend distribution, and management needs to extract cash from operations in order to make this payment.
Cash to cash is also known as the cash conversion cycle.