Measure return on investment with Cash Conversion Score

Metric Stack 9: Cash Conversion Score and more!

When raising funds for your business, it’s important to paint a picture of growth, product market fit, and profitability. However, a factor that often gets overlooked when preparing funding pitches is return on invested capital. You can use efficiency metrics to determine the right time for funding and build a story that investors just can’t resist.

I’m Priyaanka Arora, your personal metric assistant and Content Researcher & Writer at Klipfolio. This week, let’s look at the importance of measuring the long-term, potential value of investing in your business with Cash Conversion Score.

What is Cash Conversion Score?

Cash Conversion Score (CCS) is the return on each dollar invested capital. You might question how it’s different from Return on Invested Capital (ROIC), but CCS takes Annual Recurring Revenue (ARR) into the calculation instead of Net Operating Profit After Tax (NOPAT).

While you’re digesting all those acronyms, take a look at the formula for CCS:

Cash Conversion Score = ARR / (Capital Raised - Cash on Hand)

Note that Capital Raised in this formula is calculated by adding total equity and debt capital, while Cash on Hand refers to current cash. Cash Conversion Score can help you decide when to raise capital by assessing how efficiently you utilized previous funding.

I’d like to draw your attention to the point of view in that sentence you just read. “Help you decide when to raise capital”, meaning this metric is for you, just as much as it is for investors,  to assess the health and potential of your business. I’ll go into detail on this concept below, but first, let’s look at some benchmarks:

What is a good Cash Conversion Score benchmark?

Bessemer Venture Partners devised a good-better-best framework to benchmark CCS. The framework suggests that a good CCS is between 0.25-0.5X, while a better CCS ranges between 0.5-1.0X, and the best companies have a CCS greater than 1.0X.

Note that this benchmark applies to cloud companies across ARR Scale, from $5M to $150M. The median CCS for public cloud companies surveyed by Bessemer in this study is 1.3X. You might also notice the Internal Rate of Return (IRR) for each CCS range. IRR, which is an indicator of profitability and viability of investment, goes up with each increase in CCS, further reinforcing the validity of this benchmark.

Why should you care about Cash Conversion Score?

Primarily, it’s another way of looking at capital efficiency. Still, Cash Conversion Score is much more than just another efficiency metric. CCS helps in two key ways:

• Tells investors of the future potential and success of your business 

• Indicates if you’re at the optimum position to utilise funding to fuel growth

In its most basic interpretation, CCS gives you the return on each dollar invested. For example, if your CCS is 1.5X, you generate $1.3 dollars revenue for each dollar capital raised.

A CCS of 1X or more acts as an indicator that you’ve reached ideal capital efficiency. At this stage, your business will respond to incremental capital by growing - fast. As Bessemer iterates in this article, Cash Conversion Score doesn’t discourage raising capital; CCS answers the question of, “when should I raise incremental capital?”.

Other important factors to consider are LTV/CAC and product-market fit. CCS tends to increase with increasing sales efficiency and is an indicator of product-market fit. Together, these factors increase the certainty that your business will succeed in the future.

CCS gives you solid numbers that justify your confidence in your business, creating a very attractive growth story that investors can tangibly see. Essentially, you should track CCS to arm yourself with the knowledge of when your business will be most receptive to incremental capital.

What’s new on MetricHQ?

If you love learning about and discovering new metrics, MetricHQ is for you. This week features two new financial metrics useful during company valuation. Read about EBITDA Multiple and Enterprise Value, or browse through 75+ Finance metrics.

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Stay tuned for the next edition of Metric Stack Newsletter to get the latest scoop on all things metrics! Send feedback, comments, questions here: parora@klipfolio.com