cash conversion

A metric measuring how efficiently a company converts its accounting profits or revenues into actual cash flow.

Cash conversion measures a company's ability to turn its accounting profits, such as Net Income or EBITDA, into actual cash flow. While accounting rules allow companies to record revenue and earnings before cash changes hands, cash conversion focuses strictly on the physical movement of money into the business. It is a vital indicator of earnings quality, showing whether paper profits are backed by real liquidity. To calculate the cash conversion ratio, investors typically divide operating cash flow by net income or EBITDA over a specific period. A ratio of 1.0 (or 100%) means every dollar of reported net income is matched by a dollar of cash generated from operations. If the ratio is consistently below 1.0, it suggests that profits are tied up in non-cash working capital assets, such as unpaid customer invoices or unsold inventory. Investors closely monitor this metric because high earnings with poor cash conversion can signal aggressive accounting, high capital intensity, or collection issues. Conversely, strong and consistent cash conversion provides a company with the organic liquidity needed to fund share buybacks, pay dividends, and reinvest in growth without relying on expensive debt or equity dilution.

Company A reports Net Income of $100 million on its income statement. However, due to an increase in accounts receivable and inventory, its Statement of Cash Flows shows Operating Cash Flow of only $75 million. Its cash conversion is calculated as $75 million / $100 million = 0.75, or 75%.