Cash Conversion Cycle: How to Calculate and Improve It

However, organizations need to remember that shortening collection cycles is not the ultimate goal; the key is to prevent customers from falling too far behind on their payments. By being proactive and preventing delinquency, businesses can improve cash flow and maintain control over accounts receivable collection, crucial for running business efficiently. Customer response — especially when desiring to drive new ARR — relies on how efficiently the company can reduce sales and marketing costs. Referrals and word of mouth should impact these departments’ efficiency as much as possible. In regards to benchmarks, it’s important to contextualize hype within the company’s growth stage. A “1-3” hype ratio is good, but between “3-5” means that there is too much hype with too little ARR (and above 5 means there’s barely anything there).

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The Cash Conversion Ratio (CCR), also known as cash conversion rate, is a financial management tool used to determine the ratio of a company’s cash flows to its net profit. In other words, it is a comparison of how much cash flow a company generates compared to its accounting profit. Again, it is dependent on the business and industry, not to mention the stage and financial priorities of your SaaS business. It is recommended to track your cash conversion score on a quarterly basis to consistently track capital deployment and revenue generation, as well as review and refine your growth strategies per your business requirements.

Other capital efficiency metrics to track along with cash conversion score

While ROI is not driven by cash conversion score, it does point to multi-year trends, such as product/market fit as the company scales its sales and marketing efforts. When you cash conversion score combine cash conversion score with additional metrics, you can gain deeper insight into product/market fit and the scalability of your sales and marketing teams. Neither revenue growth nor efficiency score would have indicated to an investor that the next round in the company, PagerDuty’s 2017 Series C at $750MM, would generate a ~90% IRR at its IPO close only 2 years later. The reality, though, was that PagerDuty’s software had great product-market fit within the DevOps space, and the sales organization was running well. As the ratio of the ARR to total capital invested into a company, the Cash Conversion Score is effectively the return-on-investment of one dollar ever invested into a company. For both founders and investors, Cash Conversion Score is, therefore, a powerful proxy for returns.

Days of sales outstanding (DSO).

• In late 2019 Bessemer’s Mary D’Onofrio and Jeff Epstein created quite a bit of buzz with a new SaaS Metric – Cash Conversion Score (CCS) as an indicator of future success.
• One of the most important ones is the cash conversion score – the ability to turn capital into steady, sustainable growth.
• For companies, it is helpful to understand how investors will evaluate them AND to assess whether you are ready to put large funding rounds to work productively.
• This metric aids businesses in improving cash flow and profitability by expediting inventory turnover.

In contrast, companies in the start-up or growth stage tend to have low or even negative cash flows due to the required amount of capital invested in the business. In early stages, companies often find themselves earning negative profits until they reach a break-even point, thus the CRR of these companies would also be negative or low. Keeping track of cash inflows and outflows ensures you have enough liquidity to cover your requirements.

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When analyzing your cash conversion cycle, keep in mind that it depends on the industry and business nature; there is no one-size-fits-all answer. For instance, industries like fast-moving consumer goods (FMCG) and e-commerce often have an immediate cash conversion cycle, whereas heavy machinery manufacturing and construction typically experience a longer period. Vendors often look at a company’s CCC when deciding whether to offer trade credit.

There are a number of ways to determine the health and value of a small business. You can review the company’s balance sheet to see its assets, liabilities, and owners’ equity. You could analyze its cash flow statement to determine how efficiently the business manages its liquidity. You could even analyze the company’s financial ratios, like gross profit margin or return on assets. But for businesses that buy and manage a considerable physical inventory, one of the best health indicators you can monitor is the company’s cash conversion cycle.

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This Good, Better, Best Framework for Cash Conversion Score holds regardless of company stage, from $5MM of ARR to $1 billion+. Currently, public cloud companies had a median Cash Conversion Score of 1.3x at ~$100MM of revenue. Of the approximately 50 public cloud companies, fewer than five had a Cash Conversion Score below 0.5x at that scale. Calculating these three components independently shows us where in the cash conversion cycle we can focus our attention and work to improve. Once you have determined your business’s FCF and EBITDA, you can calculate the free cash flow conversion by simply dividing the two.

Accelerate payment recovery from delinquent customers and boost cash flow through automated collection workflows. Lower DSO, boost working capital, and increase productivity with our AI-driven accounts receivable platform, integrated with modern ERPs. In portfolio management, it is used to determine the number of the common shares which a company has been receiving at a specific time of conversion of each convertible security. That is the ratio of per value of convertible bond divided by the conversion price of equity.

To calculate your cash conversion score, take your current ARR and divide it by the difference between total capital raised to date and your net of current cash (your equity and debt minus cash from your balance sheet). Bessemer’s Cash Conversion Score is calculated by dividing a company’s current ARR by the total equity and debt capital raised to date net of current cash (i.e., equity and debt minus the cash on the balance sheet). The cash conversion cycle (CCC) determines how quickly a company can convert cash invested in inventory into cash flows during a specific period. A higher inventory turnover reduces the cash conversion cycle, which benefits the company’s overall efficiency. Cash flow conversion refers to the process of turning sales revenue into cash receipts. It measures how effectively a company converts its sales into actual cash inflows by managing receivables, payables, and inventory efficiently.

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While key SaaS metrics like ARR growth rate and burn rate look at growth and spending, CCS connects the dots to tell you exactly how efficient your company is using its capital. For instance, if you spend $1M to grow your revenue by $2M, you’re more efficient than a company that needs to spend $2M to get that same $2M in growth. Finance is in the perfect seat to bring out deeper insights through other financial efficiency ratios, which help to evaluate where your revenue is now and how you can forecast future growth. These SaaS financial metrics are the heartbeat of your business and the primary levers you can pull to optimize performance, growth, and access to fresh capital. Efficient companies understand how their decisions affect not just their reputation, but those of their investors.

• That’s why proper scrutiny of the books of accounts should be conducted first before making an investment decision based on CCR.
• Investors want to see the company succeed, and finance crafts that narrative through discovering the “why” behind the numbers — which extends into how capital helps to generate revenue.
• The cash conversion ratio (CCR) gives an overall picture of a company’s financial health.
• Mosaic’s point-and-click analysis and interactivity allow you to dive deeper into the key business drivers and trends behind the numbers of your present capital efficiency or overlay future forecasts.
• Your cash conversion score is one of the essential capital efficiency metrics that you can analyze through Mosaic’s pre-built templates.

The CCS calculation shows the return on investment for every dollar ever invested and ties the return to valuable annual recurring revenue. CCC is used for measuring management effectiveness by determining how fast a company can convert cash inputs into cash flows over a given production and sales period. Building robust revenue operations, establishing clear revenue recognition policies, and prioritizing strategies that increase customer acquisition, retention, and upsells can help maintain a healthy ARR.