What is the cash conversion cycle?

Cash conversion cycle is a key performance indicator that evaluates your company’s working capital efficiency. The cash conversion cycle measures on average how long your cash is tied up in net working capital (more on this later).

Simply put, net working capital is:

Receivables + Inventory – Payables

Receivables are the amounts outstanding from your customers, inventory is the stock you hold and payables are the amount you owe suppliers.

A company’s cash conversion cycle is calculated by adding the days inventory and sales are outstanding in the business, less the days payables are outstanding.

Days Inventory Outstanding (DIO) is the average number of days it takes your company to sell its inventory. It is calculated by taking:

Average Inventory value / Total Inventory Purchases X 365 Days

Days Sales Outstanding (DSO) is the average number of days it takes your company to collect payment from its customers. It is calculated by taking:

Average Accounts Receivable balance / Total Sales X 365 Days

Days Payables Outstanding (DPO) is the average number of days it takes your company to pay suppliers for goods and services received. It is calculated by taking:

Average Accounts Payable balance / Cost of Goods Sold X 365 Days

Let’s use an example to illustrate how the cash conversion cycle is calculated. Consider a business that purchases inventory from its supplier on 30 day payment terms and once received the inventory is held by the business for an average of 45 days. Once sold, customers pay within 15 days.

In this example, the cash conversion cycle is:

DIO = 45 Days

DSO = 15 Days

DPO = 30 Days

CCC = 45 + 15 – 30 = 30 Days

The Cash Conversion Cycle measures the length of time from cash leaving the business to pay suppliers to cash coming into the business from customers.

The shorter your Cash Conversion Cycle, the better your cash flow will be and the more money you’ll have available to invest in the business.

The longer your Cash Conversion Cycle, the more cash you will have tied up in working capital that can’t be invested, which might result in cash flow problems, particularly when it comes to non-trading items like meeting Corporation Tax or VAT payments or repayment of loans.