What is a good cash conversion cycle?

Shorter than the industry norm is the usual goal. The right comparison is with similar companies, since a software seller with no inventory and a shipbuilder have nothing in common here.

Should I use average balances?

Averages smooth out seasonal swings and are more accurate when balances change a lot. Ending balances are simpler and are what many exam problems use. Say which one you used.

Why use COGS for payables?

Payables mostly come from buying inventory and inputs, which are measured by COGS. Some analysts use purchases instead when they are available.

How does the cycle affect financing needs?

The longer the cycle, the more working capital the company needs to fund growth. A fast-growing firm with a long cycle can run short of cash while it reports profits.

Cash Conversion Cycle Calculator: DSO, DIO and DPO

Cash conversion cycle calculator (DSO, DIO, DPO)

The cash conversion cycle counts the days between paying for inventory and collecting cash from the customers who bought it. It adds the days a company waits to be paid and the days stock sits on the shelf, then subtracts the days it takes to pay its own suppliers. A shorter cycle means less cash tied up.

Measure the cycle

Cash conversion cycle63.9 daysDays between paying suppliers and collecting from customers.

Days sales outstanding: 45.6
Days inventory outstanding: 60.8
Days payables outstanding: 42.6
Working capital tied up: $750,000

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Try one yourself

Cedar Ridge Dental reports sales of $2,000,000, cost of goods sold of $1,320,000, receivables of $320,000, inventory of $238,000 and payables of $92,000. Use 365 days.

Three clocks in one number

Days sales outstanding (DSO) measures how long customers take to pay. Days inventory outstanding (DIO) measures how long goods are held before they sell. Days payables outstanding (DPO) measures how long the company takes to pay suppliers. The first two tie up cash and the third funds it, which is why DPO is subtracted.

Formulas

DSO = receivables / revenue x days. DIO = inventory / COGS x days. DPO = payables / COGS x days. Cash conversion cycle = DSO + DIO - DPO. The days figure is 365 for a year of revenue and COGS. Many courses use ending balances, and some use averages of the beginning and ending balances.

A worked example

A distributor has yearly revenue of $4,800,000 and cost of goods sold of $3,000,000. At year end it holds $600,000 of receivables, $500,000 of inventory and owes suppliers $350,000.

The three clocks over a 365-day year.
Measure	Calculation	Days
DSO	600,000 / 4,800,000 x 365	45.6
DIO	500,000 / 3,000,000 x 365	60.8
DPO	350,000 / 3,000,000 x 365	42.6
Cash conversion cycle	45.6 + 60.8 - 42.6	63.9

It takes about 64 days for a dollar spent on inventory to come back as cash. The working capital tied up is $600,000 + $500,000 - $350,000 = $750,000. Cutting inventory days by 10 would free about $82,192 of cash, since each day of COGS is $3,000,000 / 365.

Reading the cycle

A lower number is generally better, but the level depends on the business. Grocers and some online retailers collect from customers before they pay suppliers, which gives a negative cycle: the business is financed by its suppliers. Manufacturers with long production times and credit sales often run cycles of two to three months or more.

Watch the trend as much as the level. A cycle that lengthens year after year can mean customers are paying late, unsold stock is piling up or the company has lost its negotiating position with suppliers. Squeezing DPO too hard can damage supplier relationships, so a sensible target looks at all three clocks together.

Mistakes that cost points

Dividing inventory or payables by revenue. Both use cost of goods sold.
Adding DPO instead of subtracting it.
Mixing a quarterly revenue figure with a 365-day count. Match the days to the period.
Using a year-end balance after a seasonal spike without noting it distorts the result.
Treating a negative cycle as an error. It can be a real feature of a business that is paid first.

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