The Cash Conversion Efficiency Ratio (CCE) is a financial metric that measures how effectively a company manages its working capital and converts investments in inventory and accounts receivable into cash from revenue.
The ratio is used to evaluate a company's liquidity, operational efficiency, and overall financial health. A higher CCE ratio indicates that a company is more efficient in converting its investments in working capital into cash. The formula for calculating the CCE ratio is:
CCE Ratio = Net Sales / ((Beginning Working Capital + Ending Working Capital) / 2)
where Net Sales represent the total revenue generated by the company during a specific period, and the working capital represents the difference between current assets and current liabilities.
Here's an example of how a company can improve its CCE ratio by making operational changes:
Suppose Company XYZ has a CCE ratio of 0.75, which means that for every dollar invested in working capital, the company is only generating 75 cents in revenue. The company has identified that its inventory turnover rate is low, and it takes an average of 90 days to convert inventory into sales. Additionally, the company's collection period for accounts receivable is 60 days, which is higher than the industry average.
The company decides to implement the following operational changes:
Inventory Optimization: Company XYZ identifies that its inventory management process is inefficient, leading to a longer inventory turnover period. The company decides to implement just-in-time (JIT) inventory management techniques to improve inventory turnover. JIT will help the company reduce the amount of inventory it holds, thereby freeing up working capital and improving the CCE ratio.
Streamlined Accounts Receivable Process: Company XYZ also identifies that its collection process is slower than the industry average. The company decides to streamline its accounts receivable process, including billing and collection, to reduce the collection period. This will help the company collect cash faster and improve its CCE ratio.
After implementing these operational changes, Company XYZ's CCE ratio improves to 0.95. This means that the company is now generating 95 cents in revenue for every dollar invested in working capital, indicating that the company is becoming more efficient in managing its working capital.
Here are a few real-life examples of companies that have improved their CCE ratio through operational changes:
Dell Technologies: Dell improved its CCE ratio by optimizing its working capital management, implementing a cash conversion program, and simplifying its supply chain. As a result, the company's CCE ratio improved from 0.30 in 2013 to 0.50 in 2018.
Colgate-Palmolive: Colgate-Palmolive improved its CCE ratio by optimizing its inventory levels and implementing a more efficient supply chain. As a result, the company's CCE ratio improved from 0.80 in 2015 to 0.95 in 2018.
Starbucks: Starbucks improved its CCE ratio by streamlining its accounts receivable process and implementing a mobile order and pay system, which helped the company collect cash faster. As a result, the company's CCE ratio improved from 0.78 in 2014 to 1.04 in 2018.
In summary, the CCE ratio is an essential financial metric that measures a company's efficiency in managing its working capital and converting investments in inventory and accounts receivable into cash. By making operational changes, companies can improve their CCE ratio, which leads to better liquidity and financial health.