The cash conversion cycle

A distributor pays for goods, holds them, sells them on credit and then waits to be paid. The cash conversion cycle (CCC) measures how many days the company's own money is tied up in that loop. It is built from three shorter measures: how long customers take to pay, how long inventory sits and how long you take to pay suppliers. Every day you take out of the cycle is cash you no longer have to borrow.

At a glance

Measure	Question it answers	Based on	Lower is
DSO, days sales outstanding	How long do customers take to pay?	Revenue	Better
DIO, days inventory outstanding	How long does inventory sit before it sells?	Cost of goods sold	Better, if service holds
DPO, days payable outstanding	How long do we take to pay suppliers?	Cost of goods sold	Worse (higher DPO shortens the cycle)
CCC	How many days is our cash tied up?	DSO + DIO minus DPO	Better

The three parts

Days sales outstanding

DSO measures how many days of sales are sitting in accounts receivable.

Days sales outstanding

Average accounts receivable ÷ revenue for the period × days in the period

Use credit sales if you can separate them. Cash sales at a counter are collected on day zero and pull DSO down in a way that says nothing about your credit customers.

Days inventory outstanding

DIO is the same number as days on hand on the inventory turns page: how many days of cost of sales are held as inventory.

Days inventory outstanding

Average inventory at cost ÷ cost of goods sold for the period × days in the period

Days payable outstanding

DPO measures how many days of purchases are sitting unpaid in accounts payable.

Days payable outstanding

Average accounts payable ÷ cost of goods sold for the period × days in the period

Strictly, payables relate to purchases, not COGS. Most people use COGS because it is on the income statement and, for a distributor with stable inventory, purchases and COGS are close. If inventory rose or fell sharply in the period, purchases (COGS plus the change in inventory) is the better base.

The cycle

Cash conversion cycle

DSO + DIO − DPO

The first two terms are how long cash is out. The last is how long suppliers are, in effect, financing you.

Worked example

With invented round numbers that match the calculator's starting values, one year looks like this.

Input	Amount
Revenue	$16,000,000
Cost of goods sold	$12,000,000
Average accounts receivable	$2,000,000
Average inventory at cost	$2,400,000
Average accounts payable	$1,300,000

• DSO: $2,000,000 ÷ $16,000,000 × 365 = 45.6 days
• DIO: $2,400,000 ÷ $12,000,000 × 365 = 73.0 days
• DPO: $1,300,000 ÷ $12,000,000 × 365 = 39.5 days
• CCC: 45.6 + 73.0 minus 39.5 = 79.1 days

For about 79 days, this business has paid for goods it has not yet been paid for. One day of DSO is worth about $43,800 of cash (revenue ÷ 365), and one day of DIO or DPO is worth about $32,900 (COGS ÷ 365).

Calculator

Cash conversion cycle

Revenue for the period ($)Average accounts receivable ($)Cost of goods sold for the period ($)Average inventory at cost ($)Average accounts payable ($)Days in the period

DSO uses revenue, DIO and DPO use cost of goods sold. Use the same period and the same averaging method for every input.

How the cycle plays out in distribution

You pay before you collect

A typical distributor buys on net 30 terms, holds stock for weeks or months and sells on net 30 or longer. Even when customer and supplier terms match on paper, inventory time sits between them. This is what makes distribution working-capital heavy. In the example above, the business needs to fund 79 days of activity before a dollar comes back.

Growth consumes cash

Because receivables and inventory scale with sales, growth raises the amount tied up even if the number of days stays the same. A distributor growing 20% a year with a steady 79-day cycle needs roughly 20% more working capital each year. Profitable, fast-growing distributors run short of cash for exactly this reason.

The three levers pull against each other

Each lever frees cash and carries its own risk.

Lever	Shortens the cycle by	Watch for
Collect faster (lower DSO)	Tighter credit, prompt invoicing, active collections	Lost customers who expect terms
Hold less stock (lower DIO)	Better reorder points, clearing dead stock	Lower fill rate and lost orders
Pay later (higher DPO)	Negotiating longer supplier terms	Lost early-pay discounts, strained suppliers

The last lever is the one most often pulled badly.

What early-pay discounts cost

Supplier terms such as 2/10 net 30 mean: take 2% off if you pay within 10 days, otherwise pay the full amount by day 30. Passing up the discount lets you keep the money for 20 more days at a cost of 2% of the invoice, which makes it expensive borrowing.

Annualized cost of passing up a discount

Discount % ÷ (100% − discount %) × 365 ÷ (net days − discount days)

For 2/10 net 30:

• 2 ÷ 98 = 2.04% for 20 days of credit
• 2.04% × 365 ÷ 20 = 37.2% a year (simple rate)
• Compounded over the year: (1 + 2 ÷ 98) raised to the power 365 ÷ 20, minus 1 = 44.6% a year

For 1/10 net 30 the same arithmetic gives 18.4% simple and 20.1% compounded.

Calculator

Cost of skipping an early-payment discount

Discount (%)Discount period (days)Net due (days)Invoice amount ($)

The annualized rate is what you effectively pay to keep the cash for the extra days. If you can borrow for less than that, taking the discount usually wins.

Unless you can find no cheaper source of cash, taking the discount almost always wins. In the invented example, paying every supplier on day 10 instead of day 30 would need about $657,500 more cash ($12,000,000 ÷ 365 × 20). If every purchase carried 2/10 net 30 terms, the discounts earned would be about $240,000 a year, far more than the interest on $657,500 at any ordinary borrowing rate.

Discounts shorten DPO on purpose

Taking early-pay discounts lowers DPO and lengthens the cash conversion cycle. That is a good trade when the discount rate is higher than your cost of funds. Do not judge purchasing by DPO alone. Report discounts taken and missed next to it.

Common measurement mistakes

Mixing periods

DSO on last quarter's revenue, DIO on a trailing year and DPO on this month's payables do not add up to a real cycle. Use the same period for all three, and scale days to match (90 or 91 for a quarter, 365 for a year).

Using year-end balances only

Distributors often clean up at year end: collections push, inventory written down or counted, payables paid before the books close. Year-end balances then describe the best day of the year, not a typical one. Use an average of month-end balances.

Using revenue for DIO or DPO

Inventory and payables are carried at cost, so divide them by cost of goods sold. In the example, dividing inventory by revenue would give 54.8 days of DIO instead of 73.0, making the cycle look 18 days shorter than it is.

Leaving out what does not fit

Customer deposits, unbilled shipments, supplier rebates receivable and consigned stock all affect cash timing. Decide whether each belongs in the calculation, and apply that choice every period.

Comparing businesses with different models

A distributor that drop-ships a large share of sales holds less inventory than one that stocks everything, so its DIO is naturally lower. Compare against your own trend and against businesses with the same stocking model.

Freeing cash from the cycle

1. Pull average AR, inventory at cost and AP for the same 12 months from your ERP, using month-end balances. These numbers come straight from the receivables, inventory and payables ledgers.
2. Calculate DSO, DIO, DPO and the cycle, and put the dollar value of one day next to each.
3. Pick the lever with the most cash per day and the least customer risk. For most distributors that is slow and dead inventory, then overdue receivables.
4. Report early-pay discounts taken and missed alongside DPO, so nobody stretches payables at 37% a year to improve a ratio.

For the inventory side of the cycle in more detail, see Inventory turns, days on hand and GMROI.