What is the cash conversion cycle?

Definition

The cash conversion cycle is how long the operating trip takes, from the day cash leaves for inputs to the day customer payments come in. On the books, it is a timing reading built from inventory days, receivable days, and payable days, not a ledger account.

A wholesale bakery uses it to see how long cash is stuck in flour, ovens, and unpaid invoices. A shorter cycle means cash comes back sooner; a longer cycle means the shop is funding the gap for more days.

It is a span of days, not a dollar cushion. The three inputs are averages for a period, then combined into one cycle.

Stay with that combined span on this page. The separate day counts are inputs, not this reading.

Where it shows up

Cash flow: Related to how long cash is tied up in the operating cycle.

Balance Sheet: Related to inventory, receivables, and payables.

P&L: Related to sales and COGS, which set the denominators.

See also: Days Sales Outstanding · Days Inventory Outstanding · Days Payable Outstanding

When you look at the Statement of Cash Flows, you will not find a line with this name. A long cycle often shows up as cash lagging leftover profit, because changes in working capital are using cash.

The Balance Sheet holds the three balances that feed the day counts: inventory, accounts receivable, and accounts payable. This page turns those balances into days, then nets them.

The Income Statement supplies the denominators. Revenue and cost of goods sold set how fast those balances should turn.

When the cycle is long, cash is slower to return even if the bakery is busy. When it is short, vendors and fast collections are covering more of the wait.

A negative cycle is possible when payables stretch past inventory and receivable days. That means vendors are funding the whole trip, which is rare for a bakery that pays flour bills on ordinary terms.

How it works

Add days inventory outstanding to days sales outstanding. That is how long cash is in stock and then in unpaid invoices.

Subtract days payable outstanding. Vendors cover part of that wait, so those days come off the cycle.

The formula is inventory days plus receivable days minus payable days. The result is how many days of your own cash sit in the operating trip.

Use the same period for all three inputs. Mixing a month of sales with a year of inventory days will scramble the span.

Stay with the combined number when you read it. Do not stop at one leg and call that the cycle.

Cash flow from operations feels this span even when leftover profit looks fine. A lengthening cycle is one reason operating cash can lag.

Do not fold in a mixer purchase or a loan draw. Those sit outside the operating trip of flour, bread, and invoices.

After the month closes, recompute with the new averages. Last month's span is history; this month's balances set the next reading.

Example

Oak & Oven Wholesale counts 25 days of inventory, 30 days of receivables, and 20 days of payables. Add 25 and 30, then subtract 20, and the cycle is 35 days.

Those 35 days are the wait between paying for flour and collecting from cafes. The bakery is funding five weeks of the operating trip with its own cash.

If receivable days stay at 30 and inventory days fall to 20, the cycle drops to 30 days. Cash comes back a week sooner without a change in leftover profit.

If payable days stretch to 25 while the other two stay put, the cycle falls to 30 days as well. Vendors are covering more of the wait, which is a different lever than selling the flour faster.

A holiday bake that fills the freezer will raise inventory days first. The cycle lengthens until those loaves sell and the invoices collect.

Last quarter the same bakery ran a 40-day cycle. This month's 35 days is shorter because payables covered more of the trip.

Common mix-ups

The cash conversion cycle is not working capital. Working capital is a dollar cushion of current assets minus current liabilities; this page is a span of days.

The cash conversion cycle is not the cash effect of the accounts moving. That dollar movement belongs with changes in working capital; this page counts days.

The cash conversion cycle is not any one of the three day counts. Inventory days, receivable days, and payable days are inputs; the cycle is the net of all three.

Related terms

• Days Sales Outstanding: The average number of days it takes to collect an invoice.
• Days Inventory Outstanding: The average number of days inventory sits before it sells.
• Days Payable Outstanding: The average number of days the business takes to pay its vendors.
• Working Capital: Current assets minus current liabilities, showing short-term operating cushion.
• Changes In Working Capital: The cash effect of movements in receivables, inventory, and payables.
• Cash Flow From Operations: Cash generated or used by the day-to-day running of the business.
• Inventory Turnover: How many times inventory is sold and replaced in a period.
• Collections: The process of following up on unpaid customer invoices.