The Cash Conversion Cycle: How Long Your Cash Is Tied Up

The cash conversion cycle measures how many days pass between paying for what you sell and being paid for it. Every day in the cycle is a day your cash is sitting in stock or in customers' bank accounts instead of yours. A shorter cycle means less money tied up and less need for an overdraft.

It is also called the working capital cycle or the cash-to-cash cycle.

The three parts

• Debtor days (also called DSO): how long customers take to pay. Trade debtors ÷ sales × 365.
• Stock days (DIO): how long stock sits before it is sold. Stock ÷ cost of sales × 365.
• Creditor days (DPO): how long you take to pay suppliers. Trade creditors ÷ cost of sales × 365.

Strictly, creditor days should use purchases rather than cost of sales, but cost of sales is in every set of accounts and is close enough for most small businesses. Use the same method each time so the trend is comparable.

Worked example

A building supplies wholesaler's accounts show:

• Debtor days: £165,000 ÷ £1,200,000 × 365 = 50.2 days.
• Stock days: £95,000 ÷ £780,000 × 365 = 44.5 days.
• Creditor days: £70,000 ÷ £780,000 × 365 = 32.8 days.
• Cycle: 50.2 + 44.5 − 32.8 = 61.9 days.

Each day of the cycle ties up about £780,000 ÷ 365 = £2,137. Taking ten days off, for example by collecting debts faster, would release about £21,000 of cash.

Calculate your cycle

Use figures from your last year-end accounts, or the last 12 months of management accounts.

Shortening the cycle

• Collect faster. Invoice the day the work is done and chase on the due date. The debtor days guide covers this in detail.
• Hold less stock. Order smaller quantities more often, and stop reordering slow lines. The stock turnover and EOQ guide shows how much to order.
• Use the terms you have with suppliers. Pay on the due date, not early, but never late: paying late damages relationships and can incur statutory interest. See creditor days.

A negative cycle is possible. Businesses paid upfront, such as many retailers and subscription services, can collect from customers before they pay suppliers.