The Cash Conversion Cycle and How to Improve Yours 

The cash conversion cycle (CCC) is how many days a company has inventory, receivables, and other working capital tied up before converting them to cash. It shows how well a business manages the full cycle of ordering inventory, collecting from customers, and paying vendors. CCC is the result of how many days inventory sits on your books, plus how long it takes you to collect from customers, minus how long it takes you to pay suppliers. 

The cash conversion cycle is calculated with this formula: 

CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payable Outstanding (DPO) 

Many small businesses are flush with orders, racing to get products out the door but still dealing with constantly tight bank accounts and cash crunches because of problems with their cash conversion cycle.  

When it takes longer to sell inventory and collect from customers than it takes to pay vendors, it means you have a cash gap that you need to fund with cash on hand or through credit. When this happens, you can’t invest that same money in advertising or hiring more people.  

If expenses come up faster in a company’s cash conversion cycle than cash is coming in, business owners need to rely on financing like small business loans to fund daily operations. That limits growth, because that financing could have been used for expansion initiatives and other opportunities. 

Fortunately, there are ways to improve your cash conversion cycle so that you don’t have to worry about making payroll or getting hit with late payment fees. This guide to the cash conversion cycle shares how to calculate your company’s CCC and gives you tips on how to optimize it.  

Cash conversion cycle formula  

The cash conversion cycle formula is calculated in two stages: 

1. Calculate individual components. 

2. Calculate the CCC. 

Components 

There are three components in the CCC formula that you calculate individually with these formulas: 

• Days Inventory Outstanding (DIO) = (0.5 * (Ending Inventory + Beginning Inventory) / Cost of Goods Sold (COGS)) * # Days. 

• Days Sales Outstanding (DSO) = (0.5 * (Ending Accounts Receivable + Beginning Accounts Receivable) / Sales on Credit) * # Days.  

• Note: “Sales on Credit” excludes cash sales because the days outstanding are 0, meaning you immediately convert them to cash. 

• Days Payables Outstanding (DPO) = (0.5 * (Ending Accounts Payable + Beginning Accounts Payable) / COGS) * # Days 

Don’t worry if this looks confusing; we simplify it below so you can easily calculate and then work on improving your cash conversion cycle. 

The “# Days” must be the same for each component and is the number of days between your beginning and ending inventories. The most common day figure for calculating the annual cash conversion cycle is 365 days. 

How to calculate the cash conversion cycle 

The CCC formula uses the three components from the previous section to calculate the CCC like this: 

• CCC = DIO + DSO – DPO 

By using the numbers from your cash conversion cycle calculation, you can also see how much money is tied up on average in working capital throughout the year. Just use this formula: 

• Average dollars tied up in working capital = Average Inventory + Average Receivable – Average Payables (where the average for each is Ending – Beginning) / 2 

Here’s an example with a simulated balance sheet and income statement: 

Example Balance Sheet Numbers
Item	Beginning	Ending	Average
Inventory	$100,000	$200,000	$150,000
Accounts Receivable	$50,000	$125,000	$87,500
Accounts Payable	$60,000	$110,000	$85,000
Example Income Statement Numbers
Item	Beginning	Ending	Period Total
Sales (Credit)			$1,200,000
COGS			$720,000
Days in Period			365
CCC and Components
Metric	Formula		Result
DIO (Days Inventory Outstanding)	Avg Inv / (COGS / Days)		76.0
DSO (Days Sales Outstanding)	Avg AR / (Credit Sales / Days)		26.6
DPO (Days Payables Outstanding)	Avg AP / (COGS / Days)		43.1
DIO + DSO			102.6
CCC (Cash Conversion Cycle)	DIO + DSO – DPO		59.5
Working Capital Tie-Up ($)	Avg Inv + Avg AR – Avg AP		$152,500

This simulated business has over $152K tied up for 60 days on average. That’s money not available for marketing, paying down debt, or hiring new people. This is where knowing what a good and bad cash conversion cycle is can help you better manage your cash flow. 

What good and bad cash conversion cycle numbers are 

A great CCC is negative, because that means you convert inventory to cash faster than you have to pay suppliers. This is the equivalent of a 0% loan. There really aren’t standard benchmarks for a “good” CCC though, because every company is unique with different supplier and customer relationships. 

In any case, the higher your number, the worse your cash conversion cycle is. This is because you’re waiting for cash to become available and don’t have it on hand to cover other expenses or fund growth. If your cash conversion cycle figure is increasing or your working capital gap is not manageable, a working capital loan can help to fund daily operations while you take action to lower your CCC and increase cash flow. 

Improving your cash conversion cycle 

Here are tips to optimize your cash conversion cycle by improving each individual component: 

Higher DPO 

You can increase DPO by negotiating longer supplier credit terms. If you pay cash on delivery (COD), ask for net 45, and if you pay net 45, ask for net 90. If your supplier doesn’t agree at first, you can offer higher late payment penalties to offset their risk. 

Lower DSO 

Getting a lower DSO is possible by swapping out paper invoices and spreadsheets with automated software that sends same-day invoices and makes it easy for customers to pay online. Then you can give them an incentive for early payment by offering “2/10, net 30” terms where they get a 2% discount if they pay within 10 days. 

Lower DIO 

Lowering your DIO is doable by reviewing your past sales records to identify seasonal trends. This way, you can order only what you’ll need for upcoming months. If you’re going into a slow season, ordering less shouldn’t lose you any sales. You could even go a step further by investing in artificial intelligence software that improves forecasting accuracy and automatically orders parts or materials you need. This saves you time and allows you to focus on growing sales. It also prevents inventory from sitting on your shelves. 

The cash conversion cycle measures how long you have working capital tied up before turning it into cash. Lower numbers are better since they mean you’re not waiting for money to come in, and a negative CCC is the best as it means suppliers are funding part of your operations. Using these tips to increase days payable outstanding and decrease days sales and days inventory outstanding will improve your CCC to help you grow your business. 

SmallBusinessLoans does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.