Understanding and Optimizing Your Cash Conversion Cycle (CCC) for Startup Growth

One of the most important metrics that’s key to your startup’s growth is the cash conversion cycle, or CCC. Understanding and optimizing the CCC can better forecast funding needs and strengthen your startup’s position for future growth. It’s especially important for verifying post-product market fit, as your startup can establish itself as a growing, scaling company rather than one that’s stalling out.

Most startup founders don’t focus on CCC until their startup matures and they invest in financial leadership. However, prioritizing it earlier can create several competitive advantages, both regarding your startup’s overall financial management and liquidity and as it pertains to securing investors to help scale. An optimized CCC strengthens investor confidence by proving financial discipline and showing that your startup has a firm grasp on cash flow.

What Your Cash Conversion Cycle Actually Measures

So what does the CCC actually measure? A company’s cash conversion cycle measures the time it takes for your startup to convert its investments in resources into cash flow. A shorter CCC means that you have less capital tied up, which can allow for faster reinvestment into the growth of your startup, while a longer cycle is indicative of inefficiencies and a need for external financing to cover your operations. Think of CCC as the number of days between spending cash on your startup’s operations and receiving cash from customers.

Don’t confuse CCC with cash flow monitoring. The former focuses on gauging the efficiency of your startup’s working capital, while cash flow monitoring is a broader and ongoing practice that tracks your startup’s inflows and outflows.

CCC is also not the same as burn rate and cash runway, though they can influence these metrics. Burn rate is a measure of the rate of negative cash flow. It demonstrates how quickly your startup is losing money and cash runway and projects how long your startup can operate with its current cash reserves and burn rate before more funding is necessary. Improving CCC supports efficient cash flow management and extends the runway.

How CCC Differs for SaaS vs. eCommerce Startups

CCC differs depending on the business model. For example, SaaS startups tend to have a shorter, more predictable CCC due to their lack of inventory, while eComm startups tend to have longer, more volatile cycles driven by inventory management. For eComm, you must optimize inventory management to avoid tying up cash.

SaaS startups provide a service, not a product, so there’s no inventory to factor in. Therefore, Days Inventory Outstanding (DIO) is zero. Conversely, DIO is a critical factor in eComm startups, as more of their money is tied up in inventory.

The cash conversion cycle formula is DIO + DSO – DPO. However, SaaS startups don’t have inventory and can adapt the DIO to better represent the time taken for product and service delivery and development.

Breaking Down the Formula: DIO, DSO, and DPO

The standard formula for calculating CCC is DIO + DSO – DPO. Here’s a closer look at each element of the standard formula:

• DIO, or Days of Inventory Outstanding, is the average number of days it takes to sell inventory. A low DIO is indicative of strong inventory management, while a high DIO can signal inefficiencies, such as overstocking, poor sales forecasting or slow-moving inventory. Since SaaS startups don’t maintain inventory, this metric should be adjusted to represent the average time it takes to deliver the service. The formula for calculating DIO is:

DIO = (Average inventory / Cost of Goods Sold) x 365

• DSO, or Days of Sales Outstanding, measures the number of days it takes to collect payment after a sale is made. A low DSO demonstrates efficient management of accounts receivable and credit, while high DSOs indicate inefficient collections, poor credit policies or lackluster financial health. The formula for calculating DSO is:

DSO = (Average accounts receivable / total credit sales) x 365

• DPO, or Days Payable Outstanding, is the average number of days it takes to pay your suppliers. A high DPO shows that your startup is able to effectively manage its payments to suppliers, while a low DPO indicates that your startup is paying its bills too quickly and missing opportunities to optimize working capital. Negotiating favorable payment terms can improve DPO within sound working capital management practices. 

The formula for DPO is:

DPO = (Average accounts payable / cost of goods sold) x 365

What’s a Good Cash Conversion Cycle for Your Stage?

Generally, a low or negative CCC is ideal for your startup, but the right benchmark will vary by your market of operation and the current stage your startup is in. For instance, if you’re benchmarking CCC by industry, SaaS startups should shoot for a negative CCC to 30 days, eComm startups 45 to 90 days and service-based startups 30 to 60 days.

A good CCC for a Series A startup is usually less than 60 days, though ideally, this number is closer to 30 days. A strong CCC is important for startups entering Series A for demonstrating capital efficiency, relying less on external funding, and creating the ideal balance between growth funding and operational growth.

Ideally, a negative CCC, which demonstrates your startup is receiving customer payments before it pays suppliers, is what startups should strive for. A negative CCC means that your startup is using money from sales to pay its expenses rather than its own cash reserves, which is highly beneficial.

Why Negative CCC Is a Self-Funding Growth Engine

A negative CCC shows that your startup is operating with high financial efficiency, essentially allowing its money earned from sales to fuel operations and growth. It can create a self-funding loop that increases the available cash flow for reinvestment and reduces or eliminates the need for outside financing. However, achieving a negative CCC is not without risk. Mismanagement can strain supplier relationships and result in cash flow issues, underscoring the importance of balancing a longer DPO with the desire to maintain strong partnerships throughout the supply chain and honoring payment terms.

Strategic Approaches to Optimizing Each Component

Optimizing cash efficiency with operational effectiveness isn’t a one-time project; it’s an ongoing strategic initiative. That said, various tactics can be administered to optimize DIO, DSO and DPO and improve your CCC.

Tips for optimizing DIO include improving your startup’s demand forecasting and inventory planning. You may also adopt a just-in-time inventory model to help streamline your supply chain. You can improve DSO by implementing automated billing and early payment discounts, and increase DPO by negotiating better terms with suppliers and key partners.

While you can take steps to optimize DIO, DSO and DPO, be aware of situations where improving one might negatively impact the other. Additionally, keep in mind that over-optimization may damage existing customer and supplier relationships.

How Your Fractional CFO Monitors and Improves CCC

CCC doesn’t usually receive the attention it deserves until a financial professional either joins your startup or you elect to outsource certain tasks to a Fractional CFO. For young, growing startups, outsourcing services to a Fractional CFO can conserve costs while ensuring you have access to professional financial leadership, from creating cash flow forecasts to optimizing CCC.

A Fractional CFO provides high-level, strategic financial leadership and can help optimize DIO, DSO and DPO to improve your startup’s working capital and streamline operational efficiencies — and all at a fraction of the cost of what it would be to hire someone in-house full-time. Fractional CFOs can also support other key startup tasks, like fundraising preparation, investor reporting, forecasting, creating financial dashboards and more.

When Growth Actually Worsens Your Cash Position

While all startups strive to grow, growth can actually weaken your cash position, underscoring the importance of proper CCC management and robust financial forecasting. As your startup grows, so do its working capital requirements. Your startup may even experience a “growth penalty,” which is a term used to describe a situation where revenue increases drain cash faster than it comes in.

Some warning signs that growth is outpacing your cash generation capacity include:

• Declining cash reserves
• Increasing accounts receivable and growing accounts payable
• A heavier reliance on debt
• Higher sales, but stagnant profits
• Higher customer churn

Make Your CCC a Competitive Advantage in Your Next Round

Are you ready to optimize your CCC? Graphite Financial is here to help. As a full-service financial provider that specializes in working with startups, we’ll help you optimize your CCC to improve your fundraising position and attract more investors. Working capital efficiency is one of the aspects that investors most heavily scrutinize during due diligence, underscoring the importance of managing it properly. Contact Graphite today for more information and to schedule a consultation.

FAQ

What is the cash conversion cycle, and why does it matter for startups?

CCC is a metric that measures the time it takes for your startup to convert its investments in resources into cash flow. It matters because a shorter CCC means that you have less capital tied up, which can allow for faster reinvestment into the growth of your startup. However, a longer cycle is indicative of inefficiencies and a need for external financing to cover your operations.

How do you calculate cash conversion cycle for SaaS companies without inventory?

SaaS startups don’t carry physical inventory. That said, to calculate the CCC for a SaaS startup, remove the Days Inventory Outstanding (DIO) component and focus on the difference between Days Sales Outstanding (DSO) and Days Payable Outstanding (DPO). This measures how long it takes to collect cash from customers, minus the average time it takes to pay suppliers. The formula is as follows:

• CCC = DSO – DPO

What’s considered a good cash conversion cycle for a Series A startup?

A good CCC for a Series A startup is usually considered anything less than 30 days. However, an ideal CCC is a negative one, as this is indicative of a startup that converts its inventory to cash very quickly. Benchmarks vary by industry, but shorter CCCs tend to be better ones because it means that your startup has greater liquidity needs and relies less on external fundraising to finance its operations.

How does cash conversion cycle differ from burn rate and runway?

CCC measures the time it takes to convert a startup’s investments in inventory and other resources into cash from sales. Burn rate and cash runway are used to determine how long your startup can operate on its cash reserves. More specifically, burn rate is the rate at which your startup spends its cash and runway is the time until this cash is depleted.

Can you have a negative cash conversion cycle, and is that beneficial?

Yes, a negative CCC is ideal for your startup. A negative CCC indicates that your startup is generating cash from sales before it needs to pay your suppliers, which can lead to greater liquidity, better overall financial health and more capital for growth. Essentially, a negative CCC means that your startup is using money from sales to pay its expenses rather than its own cash reserves, which is highly beneficial.

How often should startups track their cash conversion cycle?

Consider tracking your CCC at least monthly to manage cash flow effectively. However, more frequent monitoring may be necessary if your startup is still in its very early stages or in a growth phase where expenses risk outpacing revenue.