What Is the Cash Conversion Cycle? Explanation and Examples

The cash conversion cycle (CCC) is one of the most revealing metrics in finance, offering a view of a company’s inner workings that goes deeper than its sales figures. Think of the cash conversion cycle as your company’s financial metabolism—the speed at which the business turns investments in inventory and operations into usable cash.

Learn what the cash conversion cycle is, how to calculate it, and practical ways to improve it—so you can strengthen cash flow and fund growth.

What is the cash conversion cycle?

The cash conversion cycle measures the number of days a company takes to turn cash spent on inventory and other business operations into cash from customers. A shorter cash conversion cycle shows that a company is managing its working capital efficiently, generating cash quickly from its sales. Faster conversion makes it possible to use the company’s cash for strategic investments, funding future growth, or paying down debt. A longer cash conversion cycle suggests that a company takes more time to recoup its investments, which has the potential to strain its cash position and require more external financing.

A negative cash conversion cycle means the company receives payment from its customers before it has to pay its own suppliers. This lets the business use customer cash to fund its inventory and day-to-day operations. While most companies aim for a short, low cash conversion cycle, a negative CCC is the goal for many businesses. This is especially true in retail and ecommerce, where rapid inventory turnover is common. A negative CCC lets the company build up a significant accounts payable balance as a form of free, short-term financing.

A “good” or “bad” CCC is relative—always evaluate it in the context of your industry. A CCC that is high for one sector, such as machinery manufacturing, might be standard for another sector due to different supply chains. Therefore, a cash conversion cycle analysis is most effective when comparing a company’s CCC to industry competitors or when analyzing its performance over several quarters to identify trends. A CCC of 80 days might be excellent for a large manufacturing company, but concerning for a software company with no physical inventory.

How the CCC works

• Days inventory outstanding (DIO)
• Days sales outstanding (DSO)
• Days payable outstanding (DPO)
• Bringing it all together

You can calculate your CCC by combining three working capital metrics. Each metric measures a different stage of the conversion cycle and derives from a company’s income statement and balance sheet. Let’s look at these three components and how they relate:

Days inventory outstanding (DIO)

DIO measures the average number of days for a company to sell inventory. A high DIO could indicate ineffective inventory management, slow-moving stock, or decreased customer demand. Companies with a high DIO are at greater risk of inventory obsolescence or spoilage, which can lead to markdowns and reduced profitability.

The DIO formula is:

DIO = (Average inventory / Cost of goods sold) x 365 days

Days sales outstanding (DSO)

This measures the average number of days for a company to collect payment after a sale. It reflects a company’s credit and collection processes. A high DSO means the company is slow at collecting receivables, which could create a cash flow crunch and require short-term borrowing.

The DSO formula is:

DSO = (Average accounts receivable / Revenue) x 365 days

Days payable outstanding (DPO)

Days payable outstanding (DPO) measures the average number of days a company takes to pay its suppliers for purchasing inventory. Unlike DIO and DSO, a higher DPO is generally beneficial for a company’s financial health, meaning the business is holding onto its cash for longer. This cash provides a free source of short-term financing.

The DPO formula is:

DPO = (Average accounts payable / Cost of goods sold) x 365 days

Bringing it all together

The cash conversion cycle formula links these three metrics together to show the full cycle. It starts when a company buys inventory (paying suppliers), accounts for the time it takes to sell that inventory (DIO), and then for the time it takes to collect payment from the sale (DSO). By subtracting the DPO, we get a net figure that represents the amount of time cash is tied up.

How to calculate your CCC

The cash conversion cycle formula brings the three components together:

CCC = DIO + DSO - DPO

Let’s take a hypothetical company, Widgets & Things, with the following financial data for a year:

• Average inventory: $200,000

• Cost of goods sold (COGS): $1,500,000

• Average accounts receivable: $120,000

• Revenue: $2,000,000

• Average accounts payable balance: $100,000

First, calculate each component:

DIO = (Average inventory / Cost of goods sold) x 365 days

($200,000 / $1,500,000) x 365 = 0.13 x 365 = 48.7 days

DSO = (Average accounts receivable / Revenue) x 365 days

($120,000 / $2,000,000) x 365 = 0.06 x 365 = 21.9 days

DPO = (Average accounts payable / Cost of goods sold) x 365 days

($100,000 / $1,500,000) x 365 = .07 x 365 = 25.6 days

Now, we can perform the cash conversion cycle calculation:

CCC = DIO + DSO - DPO

48.7 + 21.9 - 25.6 = 45 days

This means that it takes Widgets & Things 45 days to convert its investments in inventory and resources into cash. For this company to improve its CCC, it could focus on reducing its DIO and DSO, or increasing its DPO—perhaps by keeping less inventory on hand, collecting customer payments more rapidly, or taking longer to pay vendors.

Strategies to improve the CCC

• Improving days inventory outstanding
• Improving days sale outstanding
• Improving days payable outstanding

There are a few strategies to improve a company’s cash conversion cycle. The goal is either to reduce the time it takes to generate cash or increase the time the company holds cash. Here are some strategies to improve each of your CCC’s core metrics:

Improving days inventory outstanding

A lower DIO means faster inventory turnover:

• Implement just-in-time (JIT) inventory. A JIT system helps a company receive goods only as they are necessary for production or sale, reducing the need to hold large stockpiles.

• Improve demand forecasting. Better forecasting helps avoid overstocking slow-moving items and understocking popular ones, ensuring the company can sell inventory more efficiently.

• Streamline supply chains. Working closely with suppliers and optimizing logistics can reduce the time it takes for inventory to move from purchase to sale.

Improving days sales outstanding

Reducing DSO means a company will collect cash faster:

• Offer early payment discounts. This is an incentive for clients to pay early. For example, the commonly used “2/10 net 30” offers a 2% discount if the invoice is paid within 10 days, even though the business has a maximum of 30 days to pay.

• Automate invoicing and collections. Electronic invoicing and automated reminders can help speed up payment collection.

• Tighten credit policies. Although it might risk losing some customers, a stricter credit policy can reduce the risk of late payments and bad debt.

Improving days payable outstanding

Extending DPO lets a company hold onto its cash longer:

• Negotiate favorable payment terms. Companies can negotiate longer payment terms with suppliers. This is a delicate balance, because it’s crucial to maintain good relationships with vendors.

• Use dynamic discounting. This offers a discount to a supplier for early payment calculated on a sliding scale based on how soon the payment is made, rather than using a fixed rate. The supplier can accept the discount to get paid sooner, or decline it and wait to receive the full payment on the original invoice due date. This gives the buyer flexibility in managing its cash.

• Centralize accounts payable. Centralizing the accounts payable process can lead to better controls, optimized payment schedules, and reduced errors.