Cash Turnover Ratio
The cash turnover ratio, also known as the cash conversion cycle, is a financial metric that measures how efficiently a company manages its cash resources during its operating cycle. It evaluates the time it takes for a company to convert its investments in inventory and other resources into cash through sales. A lower cash turnover ratio indicates better cash management and a shorter operating cycle, while a higher ratio implies a longer operating cycle and potentially less efficient cash management.
The cash turnover ratio can be calculated using the following formula:
Cash Turnover Ratio = Days Sales Outstanding (DSO) + Days Inventory Outstanding (DIO) – Days Payable Outstanding (DPO)
Where:
- Days Sales Outstanding (DSO) represents the average number of days it takes for a company to collect payments from its customers after a sale has been made.
- Days Inventory Outstanding (DIO) represents the average number of days it takes for a company to sell its inventory.
- Days Payable Outstanding (DPO) represents the average number of days it takes for a company to pay its suppliers for purchases.
A lower cash turnover ratio indicates that a company is efficiently managing its cash resources by quickly converting its inventory into sales and collecting payments from customers while delaying payments to suppliers. On the other hand, a higher cash turnover ratio may signal potential cash flow issues or less efficient inventory management.
Cash Turnover RatioExample of the Cash Turnover Ratio
Let’s consider a hypothetical example of a company called ABC Corp. to demonstrate how to calculate the cash turnover ratio.
Suppose ABC Corp. has the following data:
- Days Sales Outstanding (DSO): 25 days
- Days Inventory Outstanding (DIO): 30 days
- Days Payable Outstanding (DPO): 20 days
We can calculate ABC Corp.’s cash turnover ratio using the formula mentioned earlier:
Cash Turnover Ratio = DSO + DIO – DPO
Plugging in the values:
Cash Turnover Ratio = 25 days + 30 days – 20 days
Cash Turnover Ratio = 55 – 20
Cash Turnover Ratio = 35 days
In this example, ABC Corp.’s cash turnover ratio is 35 days, which means it takes the company 35 days to convert its investments in inventory and other resources into cash through sales. This information can be used to benchmark ABC Corp.’s performance against industry peers and analyze the efficiency of its cash management during the operating cycle. Keep in mind that the ideal cash turnover ratio varies across industries, so it’s essential to compare the ratio with other companies in the same sector to get a clearer understanding of the company’s performance.
