International Research Journal of Finance and Economics

ISSN 1450-2887 Issue 24 (2009)

© EuroJournals Publishing, Inc. 2009
http://www.eurojournals.com/finance.htm

The Relationship of Cash Conversion Cycle with Firm Size and

Profitability: An Empirical Investigation in Turkey

Ali Uyar
Faculty of Economics and Administrative Sciences
Fatih University, Istanbul, Turkey
E-mail: aliuyar@hotmail.com
Tel: +90 212 8663300, Ext: 5042; Fax: +90 212 8663342

Abstract

The purpose of this article is (1) to set industry benchmarks for cash conversion
cycle (CCC) of merchandising and manufacturing companies, and to examine the
relationship between (2) the length of the CCC and the size of the firms, and (3) the length
of the CCC and profitability. The author collected data of this study from the financial
statements of the corporations listed on the Istanbul Stock Exchange (ISE) for the year
2007. The author utilized ANOVA and Pearson correlation analyses for empirical
investigation. The major findings of the study are as follows. The lowest mean value of the
CCC is found in the retail/wholesale industry, with an average of 34.58 days, and the
highest mean value of the CCC is found in the textile industry, with an average of 164.89
days. There is a significant negative correlation between the CCC and the variables; the
firm size and the profitability. The findings of this paper are based on a study conducted on
the ISE. Hence, the results are not generaliseable to non-listed companies. Secondly, the
sample comprises merchandising and manufacturing companies. Therefore, the results are
valid for those industries. The paper is one of the rare studies about the subject conducted
in developing countries, and also in Turkey. Secondly, the paper presents industry
benchmarks to the firms to evaluate their CCC performance.

Keywords: Cash conversion cycle, Firm size, Profitability, Turkey

JEL Classification Codes: M41

1. Introduction
Liquidity management, which refers to management of current assets and liabilities, plays an important
role in the successful management of a firm. If a firm does not manage its liquidity position well, its
current assets may not meet its current liabilities. Hence, the firm may have to find external financing
due to having difficulty in paying its short term debts. Unfortunately, every firm is not able to find
external financing easily, especially as it is in small firm case. In addition, although firms are able find
external financing, the cost of borrowing may be expensive, resulting in poorer bottom line. Jose et al.
(1996) point out this fact saying “firms with glowing long term prospects and healthy bottom lines do
not remain solvent without good liquidity management”.
A useful way of assessing the liquidity of firms is with the cash conversion cycle (CCC) (Moss
and Stine, 1993). It measures the time lag between cash payments for purchase of inventories and
collection of receivables from customers. The next section provides the definition of CCC made by
various authors. On the one hand, traditional measures of liquidity such as the current ratio and quick
International Research Journal of Finance and Economics - Issue 24 (2009) 187

ratio are useful liquidity indicators of firms; they focus on static balance sheet values (Moss and Stine,
1993). On the other hand, the CCC is a dynamic measure of ongoing liquidity management, since it
combines both balance sheet and income statement data to create a measure with a time dimension
(Jose et al., 1996).
While analysis of an individual firm’s CCC is helpful, industry benchmarks are crucial for a
company to evaluate its CCC performance and assess opportunities for improvement (Hutchison et al.,
2007). Because, the length of CCC may differ from industry to industry. Therefore, the correct way is
to compare a specific firm to the industry in which it operates. The starting point of this paper is to
provide industry benchmarks for CCC so that firms are able to evaluate their own performance, and
prevent themselves from probable liquidity problems before it is too late.
The study provides an empirical evaluation of the length of CCC of Turkish manufacturing and
merchandising companies listed on the Istanbul Stock Exchange. The organization of the remainder of
this paper is as follows. Section two defines CCC and its components. Section three provides literature
review about the CCC. Section four presents scope and methodology of the study. Section five
analyzes findings of the study, and the final section provides the concluding remarks of this paper.

2. Defining cash conversion cycle

In textbooks related to finance, CCC is mentioned in the context of working capital management
(Keown et al., 2003; and Bodie and Merton, 2000). The Cash Conversion Cycle (CCC) is used as a
comprehensive measure of working capital as it shows the time lag between expenditure for the
purchases of raw materials and the collection of sales of finished goods (Padachi, 2006, p. 49)
Day-to-day management of a firm’s short term assets and liabilities plays an important role in
the success of the firm. Firms with glowing long term prospects and healthy bottom lines do not remain
solvent without good liquidity management (Jose et al., 1996, p.33).
Definitions of cash conversion cycles are not consistent. Definitions made by various authors
are given in Table 1.

Table 1: Definition of cash conversion cycle by various authors

Description Definition Source

Cash Cycle Time The number of days between the date the firm must start Bodie and Merton (2000, p.89)
to pay cash to its suppliers and the date it begins to
receive cash from its customers.
Cash Conversion Cycle The sum of days of sales outstanding (average collection Keown et al. (2003, p.109)
period) and days of sales in inventory less days of
payables outstanding.
Cash Cycle The number of days that pass before we collect the cash Jordan (2003, p. 643)
from sale, measured from when we actually pay for the
inventory.
Cash Gap It measures the length of time between actual cash Eljelly (2004, p.50)
expenditures on productive resources and actual cash
receipts from the sale of products or services.
Keown et al. (2003, p. 109) express cash conversion cycle with the following equation similar to many researchers as follows:

Cash Days of Sales Days of Sales Days of

Conversion = + - Payables
Outstanding in Inventory
Cycle Outstanding
In the formula above, the three variables to which CCC is dependent are defined as follows:
188 International Research Journal of Finance and Economics - Issue 24 (2009)

Days of Sales Outstanding = Accounts receivables

Sales / 365

Days of Sales in Inventory = Inventories

Cost of goods sold / 365
Accounts payables
Days of Payables Outstanding =
Cost of goods sold / 365

Figure 1: The cash conversion cycle

Inventory Inventory
purchased sold

Accounts receivable
Inventory period
period
Time

Accounts
Cash conversion
payable period
cycle
Cash
received
Operating cycle
Source: Jordan, 2003, p.643

Cash conversion cycle is likely to be negative as well as positive. A positive result indicates the
number of days a company must borrow or tie up capital while awaiting payment from a customer. A
negative result indicates the number of days a company has received cash from sales before it must pay
its suppliers (Hutchison et al., 2007, p.42). Of course the ultimate goal is having low CCC, if possible
negative. Because the shorter the CCC, the more efficient the company in managing its cash flow.
From the equation of CCC above, it is seen that a firm can reduce its need for working capital
by (Bodie and Merton, 2000, p.90):
• Reducing the amount of time that goods are held in inventory. This can be accomplished by
improving the inventory control process or by having suppliers deliver raw materials
exactly when they are needed in the production process.
• Collecting accounts receivable more quickly. Among the methods available to speed up the
collection process are improving the efficiency of the collection process, offering discounts
to customers who pay faster, and charging interest on accounts that are overdue.
• Paying its own bills more slowly.

3. Review of literature
Liquidity management is necessary for all businesses, small, medium or large. Because, it means
collecting cash from customers in time so that having no difficulty in paying short term debts.
Therefore, when a business does not manage its liquidity well, it will have cash shortages and will
result in difficulty in paying obligations. As a result, in addition to profitability, liquidity management
is vital for ongoing concern.
Corporate liquidity is examined from two distinct dimensions: static or dynamic views
(Lancaster et al., 1999; Farris and Hutchison, 2002; and Moss and Stine, 1993). The static view is
based on commonly used traditional ratios, such as current ratio and quick ratio, calculated from the
balance sheet amounts. These ratios measure liquidity at a given point in time whereas dynamic view
International Research Journal of Finance and Economics - Issue 24 (2009) 189

measures ongoing liquidity from the firm’s operations. As a dynamic measure of the time it takes a
firm to go from cash outflow to cash inflow which is measured by cash conversion cycle.
In a study conducted by Moss and Stine (1993) on retail firms revealed that firm size is a factor
in the length of the CCC. The study indicated that larger firms have shorter CCC. Another significant
finding of the same study is that when the CCC is compared to the current and quick ratios, a
significant positive relationship was found.
The studies that empirically examine the relationship between profitability and liquidity
showed that there exists a significant and negative relation between profitability and CCC (Jose et al.,
1996; Eljelly, 2004). Another study conducted over 22,000 public companies by Hutchison et al.
(2007) indicated a direct correlation between shorter CCC and higher profitability for 75% of
industries.
Schilling (1996) mentions optimum liquidity position, which is minimum level of liquidity
necessary to support a given level of business activity, in his writing. Briefly, he says it is critical to
deploy resources between working capital and capital investment, because the return on investment is
usually less than the return on capital investment. Therefore, deploying resources on working capital as
much as to maintain optimum liquidity position is necessary. Then he sets up the relationship between
CCC and minimum liquidity required such that if the CCC lengthens, the minimum liquidity required
increases; conversely, that if the CCC shortens, the minimum liquidity required decreases.

4. Scope and methodology

The study aims to investigate the relationship between the length of the CCC and the size of the firms,
and the length of the CCC and profitability.
The data used in this study was obtained from the financial statements of the corporations listed
on the Istanbul Stock Exchange (ISE). The financial statements were downloaded from the official web
site of the ISE (Istanbul Stock Exchange, 2007) for the year 2007. The sample comprises
merchandising and manufacturing companies from seven industries (i.e. food, paper, metal, metalware,
cement, chemicals and textile), a total of 166 corporations. Service companies are not within the scope
of this study, therefore, they are not included.
For the purpose of the study, firm size is measured by total assets and sales revenue, and
profitability is measured by return on assets and return on equity.

5. Analysis of findings
Table 2 gives the descriptive statistics for the main variables used in this study. Mean sales value and
mean total assets for the sample companies is 794,640,215 New Turkish Liras (YTL) and 624,643,053
YTL respectively. Mean CCC value is 102.38 days for all companies. The lowest mean value of the
CCC is found in the retail/wholesale industry, with an average of 34.58 days, followed by the
chemicals, metalware, food, metal, cement, paper, and textile industries. The retail/wholesale industry
has lower mean value of the CCC, compared to manufacturing industries. The reason behind this is that
the retail/wholesale industry stores inventory shortest, with an average of 54.72 days. Manufacturing
industries, all industries except retail/wholesale industry in this study, store inventory longer, because
production process lengthens days in inventory. Other studies also show that the retail/wholesale
industry has shorter CCC than manufacturing industry (Jose et al., 1996; Garcia-Teruel and Martinez-
Solano, 2007). The highest mean value of the CCC is found in the textile industry, with an average of
164.89 days. The reason behind this is that the textile industry stores inventory longest, with an
average of 133.06 days, and takes most time to collect payments from its customers, with an average of
97.76 days. This finding signals that the textile industry is having difficult times in the country. The
industry representatives say that things are not going well in the last years, therefore, expect support
from the government peculiar to the industry.
190 International Research Journal of Finance and Economics - Issue 24 (2009)
Table 2: Mean values, by industry

Industry INV AR AP CCC Total Assets (YTL) Sales Revenue (YTL)

Food 114.53 43.84 58.96 99.41 426,230,941 424,362,776
Paper 77.34 73.13 39.69 110.78 249,884,980 168,430,319
Chemicals 78.41 70.51 85.35 63.57 1,140,870,092 2,064,290,632
Metal 99.76 46.55 46.63 99.67 993,894,443 820,196,587
Metalware 78.14 66.97 60.44 84.67 920,332,125 1,188,164,249
Cement 88.82 55.57 37.16 107.23 496,642,329 315,135,683
Retail/Wholesale 54.72 48.90 69.04 34.58 989,494,169 1,867,828,175
Textile 133.06 97.76 65.93 164.89 157,858,594 133,718,924
Total 94.89 66.11 58.62 102.38 624,643,053 794,640,215

Figure 2 provides the comparison of CCC of the industries visually. The most striking point is
the height of CCC in textile industry as expressed before. On the contrary, merchandise industry has
the shortest CCC. Chemicals have also relatively short CCC compared to others. The length of CCC in
other industries is not much different than each other. Almost parallel movement of the inventory
period and CCC shows how important role inventory period plays on the length of CCC in our study.

Figure 2: CCC performance of industries

180
160
140 INV
120
100 AR
80 AP
60
40 CCC
20
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In order to investigate whether there is a significant difference among industries in terms of the
CCC, one-way ANOVA analysis with Duncan test from Post-Hoc tests was conducted (see Table 3).
The results show that the retail/wholesale, the chemicals, and the metalware industries have
significantly (at 0.01 level) shorter CCC than the textile industry.

Table 3: One-way ANOVA analysis

Sum of Squares df Mean Square F Sig.

Between Groups 208063.530 7 29723.361 2.754 .010
Within Groups 1705245.179 158 10792.691
Total 1913308.709 165
International Research Journal of Finance and Economics - Issue 24 (2009) 191
Duncan a, b test

Industry N Subset for alpha =.05

1 2
Retail/Wholesale 10 34.58
Chemicals 23 63.57
Metalware 26 84.67
Food 23 99.41 99.41
Metal 13 99.67 99.67
Cement 24 34.58 107.23
Paper 17 110.78 110.78
Textile 30 164.89
Sig. .056 .091
Notes: Means for groups in homogeneous subsets are displayed; a uses harmonic mean sample size = 18.342; b the group sizes are unequal. The
harmonic mean of the group sizes is used. Type I error levels are not guaranteed.

5.1. CCC & Firm size

Another important aim of the study is to demonstrate the relationship between the cash conversion
cycle and firm size for which two measurements were used; net sales and total assets. For this purpose
Pearson correlation analysis was conducted (see Table 4). The analysis produced the following
significant results for the two firm size measurements; there is a significant negative correlation
between the CCC and the firm size in terms of both net sales and total assets. This means the larger the
firm size, the shorter the CCC or the smaller the firm size, the longer the CCC. This finding indicates
that the smaller firms should look for ways to shorten their CCC by shortening inventory period and
accounts receivable period, lengthening accounts payable period.

5.2. CCC & Profitability

To the relationship between the cash conversion cycle and profitability, two measurements were used;
return on assets (ROA) and return on equity (ROE). For this purpose Pearson correlation analysis was
conducted (see Table 4). The results indicated that there is a significant negative correlation between
the CCC and ROA, but there is not a significant correlation between the CCC and ROE. The firms with
shorter CCC are more likely to be more profitable than the firms with longer CCC. A probable
explanation to this finding is that when the CCC is relatively shorter, the firm may not need external
financing, which results in incurring less borrowing cost. Hence, profitability increases.

Table 4: Correlation matrix

CCC Sales revenue Total assets ROA ROE

CCC 1 -.157* -.128 -.208** .062
Sig. (2-tailed) .043 .099 .007 .425
N 166 166 166 166 166
Sales revenue -.157* 1 .850** .135 .089
Sig. (2-tailed) .043 .000 .083 .253
N 166 166 166 166 166
Total assets -.128 .850** 1 .140 .078
Sig. (2-tailed) .099 .000 .072 .319
N 166 166 166 166 166
ROA -.208** .135 .140 1 .419**
Sig. (2-tailed) .007 .083 .072 .000
N 166 166 166 166 166
ROE .062 .089 .078 .419** 1
Sig. (2-tailed) .425 .253 .319 .000
N 166 166 166 166 166
Notes: * Correlation is significant at the 0.05 level (2-tailed);
**Correlation is significant at the 0.01 level (2- tailed)
192 International Research Journal of Finance and Economics - Issue 24 (2009)

6. Conclusion
This study, which was conducted on listed companies in the Istanbul Stock Exchange, presents the
mean values of cash conversion cycle for various industries comparatively. The paper showed that
retail/wholesale industry has shorter CCC than manufacturing industries. The main reason for this is
that retail/wholesale industry do not manufacture goods, rather it keeps ready-for-sale goods in its
warehouse. Hence, it has shorter days in inventory. Secondly, the retail/wholesale industry makes cash
sales or credit sales with short maturity. Moreover, the retail/wholesale industry is slower in paying its
accounts payable to its suppliers. Another important finding of the study is that the textile industry has
the longest CCC, therefore, the industry may have liquidity problems.
Moreover, the finding indicated a significant negative correlation between the length of CCC
and the firm size, in terms of both net sales and total assets. Hence, smaller firms have longer CCC.
This finding is parallel to the finding of the study conducted by Moss and Stine (1993). Since longer
cash conversion cycles are associated with smaller firms, this offers a strong incentive for these firms
to better manage their cash conversion cycle (Moss and Stine 1993).
Lastly, the significant negative correlation between the length of CCC and the profitability is
another important finding of the study. The message to the firms is that the longer CCC, the less
profitable you are. The probable reasons are keeping inventory for a long time, being slow in collecting
receivables, and paying debts quickly.
International Research Journal of Finance and Economics - Issue 24 (2009) 193

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