A higher, or quicker, inventory turnover decreases the cash conversion cycle (CCC). A lower, or slower, inventory turnover increases the CCC. The CCC measures the number of days it takes a company to generate and collect revenue from its inventory assets. Stated differently, the CCC measures the time it takes a company to purchase its inventory and then collect cash from its sales.
Cash conversion cycle = days inventory outstanding + days sales outstanding - days payables outstanding
A company's inventory turnover affects the CCC in that it is used in the calculation for days inventory outstanding:
Days inventory outstanding = average inventory / cost of goods sold per day
When a company's inventory turnover is high, meaning it cycles through inventory quickly, it reduces the average inventory, and therefore decreases the days inventory outstanding. When a company's inventory turnover is low, meaning inventory sits on its books for an extended period of time, it increases the average inventory, and therefore increases the days inventory outstanding.
When the days inventory outstanding is low, it reduces the CCC. This means a company is able to collect cash from revenues quickly; the business is able to use its working capital in other areas. When the days inventory outstanding is high, it increases the CCC. This means it takes a company longer to collect its cash from revenues, which causes potential cash flow issues to arise when it company needs working capital.