Since its introduction in the 1980s, the cash conversion cycle (CCC) has become a key performance indicator (KPI) for corporate working capital management (WCM). The CCC represents the net length of time that funds are tied up in operating working capital by accounting for the turnover periods of inventory, accounts receivable and accounts payable. The CCC is calculated as days’ inventory held (DIH) plus days’ sales outstanding (DSO), minus days’ payables outstanding (DPO). All else equal, a shorter CCC results in increased operating cash flow and improved liquidity.

To determine the degree that corporate WCM has improved over the past four decades, we examined the trend in the CCC for a large sample of public firms. Our data analysis indicates significant reductions in the CCC over the sample period. Interestingly, most of the efficiency gains occurred between 1975 and 2001. From 2001 to 2016, the CCC exhibited only minor variability. This result may suggest that, in aggregate, there are fewer remaining areas in the working capital supply chain that will easily enable further reductions in the CCC. It is likely, however, that inefficiencies in WCM still exist in certain industries.   

Findings: A significant decrease in the CCC

In 1975, the annual median CCC was 101.66 days. That is, a firm at the 50th percentile of the CCC in 1975 had funds tied up in operating working capital on a net basis for 101.66 days. From 1975 throughout the 1980s, the median value for the CCC dropped in a fairly steady fashion, reaching a value of 78.68 days in 1989. The dramatic decrease in the CCC continued throughout the 1990s and into the 2000s.

By 2001, the annual median CCC dropped to 50.05 days. Other than a slight spike in 2006 and 2007 (likely due to the financial crisis), the annual median CCC displayed little variability between 2001 and 2016. The distribution of the annual median CCC values over the sample period indicates that most of the incremental improvements in working capital efficiency occurred between 1975 and 2001.

To provide further insights, we next compared the annual median CCC over the endpoints of the sample period. The median CCC dropped from 101.66 days in 1975 to 49.98 days in 2016. The 51.68 day reduction in the CCC is significant at all conventional statistical significance levels. This reduction indicates a 50.84 percent decrease, which translates to an annualized decrease of -1.78 percent per year over the 42-year sample period.

Findings: Which components of the CCC drive the observed decrease?

Given the dramatic downward trend in the CCC, the drivers influencing this KPI are of interest. A declining trend in days inventory outstanding (DIO) was apparent over the sample period. Between 2001 and 2016, the median value for DIO ranged between 44.3 days (2008) and 50.4 days (2016). Comparing the endpoints of the sample period, we observed that the median DIO dropped markedly from 88.07 days in 1975 to 50.40 days in 2016. This drop is consistent with improvements in inventory management techniques and in supply chain management that have reduced inefficiencies in filling orders.

Another factor contributing to the downward trend in the CCC is the change in trade credit use. Over the endpoints of the sample period, the median DSO dropped by 1.03 days. The observed decrease in the DSO is consistent with efficiencies in corporate collections made during the sample period (e.g., regulatory changes and the development and implementation of new payment technologies). Unlike the DSO, the median DPO increased substantially from a median of 31.39 days in 1975 to 49.15 days in 2016. These findings indicate that firms have reduced their collection periods while simultaneously increasing their time to pay. The net result is a shorter CCC.

Overall, the data analysis indicates that the shorter CCC is primarily attributable to improvements in inventory management and more lenient payables terms. While firms appear to have improved collection efficiencies, the gains are modest.

Implications: Cash accumulation

Since a shorter CCC leads to increased operating cash flow and improved firm liquidity, a potential implication of the trend in the CCC is cash accumulation. We examine this by comparing the temporal change in the sample firms’ days’ cash held (DCH), which is calculated as cash and equivalents divided by average daily operating expenses. From 1975 to 2016, the median DCH almost doubled from 99.47 days to 197.56 days. The latter suggests that the median sample firm in 2016 carried enough cash to cover roughly 198 days of operating expenses.

The observed accumulation of cash is consistent with the aforementioned shortening of the corporate CCC, which has freed up vast sums of cash flow from operating working capital. It appears that managers have retained a substantial proportion of operating cash flow in the form of cash and equivalents. To be clear, the increased cash flow resulting from the shorter CCC has likely led to other uses of cash, beyond simply cash accumulation. Examples include corporate payouts (e.g., dividends and share repurchases), mergers and acquisitions activity, and the repayment of debt.

Implications: What does the future hold for the CCC?

Our data analysis clearly shows that corporations have become much more efficient in managing working capital over the past few decades. This is likely due to treasury managers squeezing blatant inefficiencies (i.e., low hanging fruit) out of the working capital supply chain. Despite this dramatic improvement, future trends in the CCC remain an open question.

Matthew Hill, PhD, CTP, FP&A, is Director, Center for Treasury and Financial Analytics, Assistant Professor of Finance, College of Business, Arkansas State University. Jim Washam, PhD, CTP, FP&A, is Associate Dean and McAdams Frierson Professor of Bank Management, College of Business, Arkansas State University.