Cash Conversion Cycle: Linking Receivables, Payables, and Inventory into One System

1) The Cash Conversion Cycle (CCC) as the “system KPI”

The cash conversion cycle (CCC) measures how many days cash is tied up in the operating cycle. It links three time-based metrics—how fast you collect from customers, how long inventory sits before it is sold, and how long you take to pay suppliers—into one number that connects day-to-day operational choices to liquidity.

Core identity:

CCC (days) = DSO + DIO − DPO

Think of it as: days cash is out (inventory + receivables) minus days suppliers finance you (payables).

DSO: Days Sales Outstanding (collection speed)

Definition: average number of days it takes to collect cash after a sale is made on credit.

Common formula:

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DSO = (Average Accounts Receivable / Credit Sales) × Days

In practice, many teams use total revenue as a proxy if credit sales are not separately tracked, but the cleanest approach uses credit sales.

DIO: Days Inventory Outstanding (inventory speed)

Definition: average number of days inventory is held before it is sold (or used in production and sold).

Common formula:

DIO = (Average Inventory / Cost of Goods Sold) × Days

COGS is typically used because inventory is carried at cost, not selling price.

DPO: Days Payables Outstanding (supplier financing)

Definition: average number of days the company takes to pay suppliers.

Common formula:

DPO = (Average Accounts Payable / Cost of Goods Sold) × Days

Some companies use purchases instead of COGS if purchases data is reliable; the goal is to match payables to the cost base they fund.

2) Interpreting CCC: what “shorter” or “longer” means

CCC as a liquidity and financing signal

• Shorter CCC generally means cash returns faster to the business. This reduces the need for external financing (revolver usage, factoring, short-term debt) and improves resilience during demand shocks.
• Longer CCC means cash is tied up for more days. The business may need more working-capital funding to support the same level of sales, especially during growth.

Important nuance: “shorter” is not always “better”

Because CCC is a system KPI, improving it mechanically can damage other outcomes:

• Reducing DSO by tightening credit may reduce sales volume or push customers to competitors.
• Reducing DIO by cutting inventory may increase stockouts, expedite costs, or lost revenue.
• Increasing DPO by paying later may strain supplier relationships, reduce priority allocation, or eliminate early-pay discounts.

The right CCC is the one that supports the company’s strategy (service level, growth, margin) while keeping liquidity risk acceptable.

3) Directional impact of common actions (what moves DSO, DIO, DPO, and CCC)

Because CCC = DSO + DIO − DPO, the direction is straightforward:

• Lower DSO → lower CCC (cash comes in sooner).
• Lower DIO → lower CCC (cash tied up in inventory for fewer days).
• Higher DPO → lower CCC (suppliers fund more days).

Actions and their typical directional effects

Practical step-by-step: using CCC to evaluate a proposed change

1. State the operational action (e.g., “reduce safety stock on SKU family A”).
2. Translate it into a metric movement (e.g., “inventory days should drop by ~8 days”).
3. Update CCC using CCC = DSO + DIO − DPO.
4. Convert days into cash impact using a daily cost or sales base (examples below).
5. List second-order effects (service levels, supplier pricing, customer churn) and assign owners to monitor them.

4) Cross-functional tension: why CCC improvements require alignment

CCC is a shared outcome created by different teams optimizing different objectives. The friction is predictable; naming it explicitly helps you manage it.

Sales priorities vs. DSO

• Sales goal: maximize revenue, win deals, keep customers happy.
• CCC tension: sales may prefer looser credit terms or tolerance for overdue accounts to protect relationships.
• Alignment tool: define “guardrails” (approved term ranges by segment, escalation paths for exceptions) and measure profitable growth, not just bookings.

Procurement priorities vs. DPO

• Procurement goal: secure supply, negotiate price, maintain supplier performance.
• CCC tension: pushing DPO higher can trigger price increases, reduced service, or loss of early-pay discounts.
• Alignment tool: segment suppliers (strategic vs. transactional) and tailor payment strategies; treat terms as part of total cost, not a standalone win.

Operations priorities vs. DIO

• Operations goal: high service levels, stable production, low expediting.
• CCC tension: reducing inventory days can increase variability risk and stockouts.
• Alignment tool: set explicit service-level targets and use inventory reductions where variability is controllable (forecast accuracy, lead time reduction, SKU rationalization).

Finance priorities vs. the full CCC

• Finance goal: liquidity, covenant headroom, funding efficiency, cash forecasting accuracy.
• CCC tension: finance may push for aggressive CCC improvements that create hidden operational costs or revenue leakage.
• Alignment tool: convert CCC changes into cash and into operational KPIs (fill rate, churn, supplier on-time delivery) so trade-offs are visible.

5) Worked example: calculate CCC and estimate cash released

Assume a company tracks the following annual figures (365-day year):

• Annual revenue: $120.0m
• Annual COGS: $72.0m
• Average Accounts Receivable (A/R): $16.0m
• Average Inventory: $12.0m
• Average Accounts Payable (A/P): $10.0m

Step 1: compute DSO

DSO = (Avg A/R / Revenue) × 365

DSO = (16.0 / 120.0) × 365 = 48.7 days

Step 2: compute DIO

DIO = (Avg Inventory / COGS) × 365

DIO = (12.0 / 72.0) × 365 = 60.8 days

Step 3: compute DPO

DPO = (Avg A/P / COGS) × 365

DPO = (10.0 / 72.0) × 365 = 50.7 days

Step 4: compute CCC

CCC = DSO + DIO − DPO

CCC = 48.7 + 60.8 − 50.7 = 58.8 days

Interpretation: on average, cash is tied up for about 59 days from paying for inputs (net of supplier terms) to collecting from customers.

Step 5: model improvements from common actions

Suppose the company executes three initiatives:

• Improve collections: DSO decreases by 5 days (48.7 → 43.7)
• Reduce safety stock: DIO decreases by 8 days (60.8 → 52.8)
• Negotiate longer terms: DPO increases by 4 days (50.7 → 54.7)

New CCC:

New CCC = 43.7 + 52.8 − 54.7 = 41.8 days

CCC improvement: 58.8 − 41.8 = 17.0 days shorter.

Step 6: translate “days” into approximate cash released

A practical approximation is to convert CCC days into dollars using a daily operating cost base. Because DIO and DPO are cost-based and A/P is cost-based, many teams use daily COGS as a consistent base for a quick estimate:

Daily COGS = Annual COGS / 365 = 72.0m / 365 = $0.197m per day

Approximate cash released from a 17-day CCC reduction:

Cash released ≈ 17.0 × $0.197m = $3.35m

This is an approximation, but it is useful for sizing: a ~17-day improvement corresponds to roughly $3.4m less cash tied up in the operating cycle at the current scale.

Optional cross-check: attribute cash release by lever (quick sizing)

If you want a directional split by initiative, you can size each lever using the most relevant daily base:

• DSO improvement (5 days) uses daily revenue: Daily revenue = 120.0m/365 = $0.329m → cash impact ≈ 5 × 0.329 = $1.65m
• DIO improvement (8 days) uses daily COGS: 8 × 0.197 = $1.58m
• DPO improvement (4 days) uses daily COGS: 4 × 0.197 = $0.79m

These add to ≈ $4.02m. The difference versus the single-base CCC estimate reflects that CCC mixes revenue-based (DSO) and cost-based (DIO/DPO) components; choose one method consistently for decision-making, and use the split view to understand which lever is doing the work.