Cash conversion cycle: combine inventory, collection and payment days
Add inventory and customer-collection days, subtract supplier-payment days, and keep the underlying period and valuation bases consistent.
Method
The cash conversion cycle estimates an operating timing gap, not profit or the amount of cash required. Days inventory outstanding represents stock holding, days sales outstanding represents customer collection, and days payable outstanding represents supplier payment. Add inventory days and collection days, then subtract payment days. The supplier period offsets part of the time before customer cash arrives; it is not another delay to add.
Use day estimates drawn from a consistent period and document their definitions. Inventory valued at cost should be compared with cost of goods sold, not sales revenue. Customer collection uses the relevant credit-sales basis. Supplier-payment estimates may use purchases or a cost-of-sales proxy; record the basis rather than silently changing it between comparisons. Average balances should represent the period, especially when stock or sales are seasonal.
- Inventory + collection45 + 20 = 65 days
- Supplier-payment period30 days
- Cash conversion cycle65 − 30 = 35 days
Inventory days and collection days are added. Supplier-payment days are subtracted, using consistent period definitions.
Worked example
Suppose average inventory at cost is 18,000 and cost of goods sold over 365 days is 146,000. Inventory days are 45. For the same period, assume the records give collection days of 20 and supplier-payment days of 30. The cycle is 45 + 20 − 30 = 35 days. This is an aggregate model; it does not mean every item sells or every customer pays on those dates.
In Days inventory outstanding, enter inventory 18,000, cost of goods sold 146,000 and period 365. Then enter 45, 20 and 30 in Cash conversion cycle. Keeping the other inputs fixed, collection days of 10 give a 25-day cycle. Alternatively, inventory days of 35 with collection 20 and payment 30 also give 25 days. These separate scenarios show arithmetic sensitivity, not a promise that either operational change can be achieved.
18,000 ÷ 146,000 × 365 = 45
45 + 20 − 30 = 35
45 + 10 − 30 = 25
35 + 20 − 30 = 25
- Base case
- 35 days
- Collection: 10 days
- 25 days
- Inventory: 35 days
- 25 days
The base case is inventory 45, collection 20 and payment 30 days. Each alternative changes only one input.
Checks and limits
A negative cycle can occur when customers pay before suppliers, but it does not establish profitability or solvency. Averages can hide overdue invoices, obsolete stock and cash shortages on particular dates. Two opening-and-closing stock balances may poorly represent a seasonal year. Compare equivalent definitions over time, inspect ageing and payment schedules, and respect supplier terms. This calculator does not prescribe a target cycle, a credit policy or how much borrowing a business needs.
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Source: OpenStax — Principles of Finance