What Is the Cash Conversion Cycle and How Do You Calculate It?
Sam's List Editorial | 2026-07-31
What Is the Cash Conversion Cycle and How Do You Calculate It? The cash conversion cycle is the number of days between paying for something and getting paid for it. You buy inventory or pay for labor, you hold it, you sell it, you wait to collect, and somewhere in there you pay your suppliers. The cycle counts the days your own money is tied up in that loop. Put less politely: it is the number of days your cash is somebody else's working capital. This is the number that explains the most frustrating situation in small business, which is being profitable and broke at the same time. Profit is an opinion about a period. The cash conversion cycle is a measurement of how long your money is unavailable. The Cash Conversion Cycle Formula, Broken Into Three Parts The cycle is three measurements combined: Cash conversion cycle = DIO + DSO minus DPO Each part is a days figure, and each uses a different denominator, which is the detail that trips people up. Days inventory outstanding. Average inventory divided by cost of goods sold, times the number of days in the period. This is how long inventory sits before it sells. A service business with no inventory has a DIO of zero, which is why service businesses have shorter cycles by nature. Days sales outstanding. Average accounts receivable divided by revenue, times days in the period. This is how long customers take to pay after you invoice. It uses revenue as the denominator because receivables are recorded at selling price. Days payables outstanding. Average accounts payable divided by cost of goods sold, times days in the period. This is how long you take to pay suppliers. Longer is better for your cash and worse for your supplier relationships, which is the tension in the whole exercise. Use average balances, not the balance on the last day of the period. Take the beginning and ending balance and average them at minimum. A point-in-time balance in a seasonal business can be wrong by weeks in either direction, and December 31 is usually the least representative day of the year. A Worked Example Here is a distributor with plain numbers, run over a full year of 365 days. This arithmetic is illustrative, not data from any business. Annual revenue of 2,400,000. Cost of goods sold of 1,440,000, so a 40 percent gross margin. Average inventory of 200,000. Average accounts receivable of 280,000. Average accounts payable of 100,000. Measure Calculation Result Days inventory outstanding 200,000 / 1,440,000 × 365 50.7 days Days sales outstanding 280,000 / 2,400,000 × 365 42.6 days Days payables outstanding 100,000 /...
