Cash conversion cycle:
formula and worked example

Why the cash conversion cycle shapes your working-capital budget

The cash conversion cycle counts the days between the moment a business pays for the goods it sells and the moment the customer's money arrives. A trading company buys stock, holds it on the shelf, sells it on credit and eventually collects. Meanwhile its own suppliers may be waiting for payment. The number of days that nobody else is financing the operation is the cycle.

A long cycle means cash is parked in stock and receivables, and someone has to fund it: the owner's savings, an overdraft or a working-capital loan. A short cycle frees cash without a single extra sale, which is why lenders and finance managers watch the trend more closely than the profit figure for a single month.

Growth makes the cycle more demanding, not less. A firm whose sales rise 30% while its day counts stay the same needs roughly 30% more working capital, so a business can be profitable on paper and still run out of cash when it scales. That is why the cycle is often the first number a lender asks for when a growing company requests a credit line.

The formula and what each day count means

• Inventory days: how long stock sits before it is sold, normally average inventory divided by cost of goods sold, times days in the period.
• Receivable days: how long customers take to pay, normally average trade receivables divided by credit sales, times days in the period.
• Payable days: how long you take to pay suppliers, normally average trade payables divided by cost of goods sold or purchases, times days in the period.

Payables are subtracted because supplier credit finances part of the stock you are holding. The result is expressed in days, and a negative value is possible when customers pay before suppliers do.

Worked example with 48, 35 and 28 days

Take a distributor that holds stock for 48 days, collects from customers after 35 days and pays suppliers after 28 days. These are example inputs, not benchmarks for any sector.

1. 1Add the days the cash is locked in stock and receivables: 48 + 35 = 83 days.
2. 2Subtract the credit your suppliers give you: 83 − 28 = 55 days.
3. 3Read the answer as 55 days of operating cost the business must finance itself.

How to read a 55-day cycle

There is no universal good number. Grocery and fast-moving retail often run very short or even negative cycles because stock sells in days and suppliers are paid later. Machinery makers, apparel exporters and distributors of slow-moving parts commonly run cycles of months. Compare the figure with your own history and with firms that sell similar goods on similar terms.

Direction matters more than level. A cycle that creeps from 45 to 55 days over four quarters tells you that stock is ageing or customers are slipping, even if sales and margins look healthy. A sudden drop may reflect a one-off collection drive or stretched supplier payments, so look at which component moved.

Break the number down before reacting to it. Two firms can both show 55 days with very different risks: one holds all its days in stock that might become obsolete, the other in receivables from a single large customer. The same total hides different exposures, so always read the three components side by side and ask which one you could realistically change within a quarter.

What happens when one component changes

Because the formula is a plain sum, a change in inventory days passes straight through to the cycle.

A 10% rise in stock days adds 4.8 days to the cycle here, so the result moves from 55 to 59.8 days. The same 4.8 days from receivables would be worth more money than from inventory if your selling price is well above cost, because receivables are measured at sale value while stock is measured at cost.

Mistakes that distort the cycle

• Measuring inventory days on sales instead of cost of goods sold, which understates the days when margins are high.
• Using year-end balances for a seasonal business, so a festival-season peak or a post-sale trough sets the number for the whole year.
• Adding payable days instead of subtracting them, or mixing a 360-day basis for one component with a 365-day basis for another.
• Celebrating a shorter cycle created only by delaying supplier payments, which can cost early-payment discounts and goodwill.

A short routine for monthly review

1. 1Compute the three day counts from the same ledger extract and the same month-end dates.
2. 2Compare the cycle with the previous quarter and with the same month last year.
3. 3Identify which component moved and whether the cause is policy, a single large customer or a stocking decision.
4. 4Translate the change in days into money and decide where one hour of management time pays back most.

Run the exercise the same way every period. Consistent definitions make the trend trustworthy even when the absolute number is debated.

Share the result outside finance. Sales teams influence receivable days through the credit terms they agree, purchasing influences inventory days through order sizes, and the payables clerk influences payable days through payment runs. When each team sees its own component, the cycle stops being an accountant's ratio and becomes a shared operating target.