Cash conversion cycle

The number of days between paying suppliers and collecting from customers: days inventory plus days sales outstanding minus days payable.

DefinitionThe number of days between paying suppliers and collecting from customers: days inventory plus days sales outstanding minus days payable.

The cash conversion cycle measures how long cash is tied up in operations: from the day the business pays for inventory to the day it collects cash from the customer who bought it. A shorter cycle means less working capital to fund; a negative one means suppliers finance the business.

How it is computed

Cash conversion cycle = days inventory outstanding (DIO) + days sales outstanding (DSO) − days payable outstanding (DPO). DIO = average inventory ÷ cost of goods sold × days in period; DSO = average receivables ÷ revenue × days; DPO = average payables ÷ cost of goods sold × days.

Example

A distributor holds inventory for 45 days, collects in 50 and pays suppliers in 40: 45 + 50 − 40 = 55 days. On cost of goods sold of $36,500,000 a year, $100,000 a day, cutting the cycle by 10 days through inventory frees about $1,000,000 of cash.

Where it goes wrong

Mixing period-end balances with full-year flows in a seasonal business. Shortening it by paying suppliers late, which costs discounts and goodwill. The full guide is cash conversion cycle.

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